New South Wales Supreme Court CITATION : Indian Pacific Interiors Pty Ltd v Nichols [2008] NSWSC 911 HEARING DATE(S) : 27 August 2008 JUDGMENT DATE : 27 August 2008 JURISDICTION : Equity Division JUDGMENT OF : Palmer J EX TEMPORE JUDGMENT DATE : 27 August 2008 DECISION : Summons dismissed. CATCHWORDS : GUARANTEE – SUBROGATION – Whether guarantors discharged debt by paying creditors or lent money to debtors to pay debt – whether right of subrogation arose over creditors' security – whether one guarantor was entitled to appoint receiver. CATEGORY : Principal judgment PARTIES : Indian Pacific Interiors Pty Ltd (Admin app) (R&M app) (Plaintiff) Steven Nichols (Defendant) FILE NUMBER(S) : SC 3988/08 COUNSEL : S.M. Golledge (Plaintiff) J.T. Johnson (Defendant) SOLICITORS : Stacks/William Oates (Plaintiff) Yates Beaggi (Defendant) 3988/08 Indian Pacific Interiors Pty Ltd (Admin App)(R&M App) v. Nichols JUDGMENT – Ex tempore 27 August, 2008 1 The Plaintiff, Indian Pacific Interiors Pty Ltd ("the Company") was placed in voluntary administration. The Defendant is the Receiver of the Company appointed by Mrs S.G. Mathews under an equitable charge. The Administrator, in the name of the Company, seeks a declaration that the appointment of the Receiver is invalid. 2 The facts are not in dispute and may be briefly stated. Mrs Mathews was married to Mr Craig Mathews in 1996. Mr Mathews was at all material times the sole director of the Company, which carried on a joinery business. 3 Mrs Mathews had acquired a property at 4 Bayview Avenue, Hyams Beach, in her own name before she was married. In 1997, Mrs Mathews' grandmother agreed to transfer to Mr and Mrs Mathews as joint tenants her property at 24 Bayview Avenue, Hyams Beach in consideration of a promise that they would provide accommodation for her at their property. Mr and Mrs Mathews acquired other properties as joint tenants during their marriage. 4 In June 2005 Mr and Mrs Mathews each executed a separate Deed of Guarantee in favour of the Commonwealth Bank of Australia in consideration of the Bank advancing $500,000 to the Company. In support of those guarantees Mr and Mrs Mathews gave mortgages to the Bank over various properties held by them as joint tenants, including the property at 24 Bayview Avenue, Hyams Beach. 5 On 17 July 2005 the Company executed an all monies equitable mortgage and a floating charge in favour of the Bank as further security for the loan of $500,000. 6 Mr and Mrs Mathews were divorced in March 2006. There was no formal property settlement between them. Mrs Mathews gave the following unchallenged evidence as to what was agreed between herself and Mr Mathews at the time of their divorce: "Craig and I have not entered into any formal property settlement arrangement with respect to division of our assets. During the course of the divorce proceedings, I recall having a conversation with Craig to the following effect: SM: 'I don't want us to have to put everything to market and effectively fire sale all of our assets at below value. I would be happy to keep all the properties, and you can keep the businesses. I've owned 4 Bayview Avenue since before we were married, and my grandmother obviously wants me to have 24 Bayview Avenue – so that's the fair thing to do. I will look after the mortgages against the properties which pertain to the properties, and you will need to look after the facilities which relate to the businesses.' CM: 'Great. I am happy with that also.'" 7 The Company's loan from the Bank became payable in early July 2007. Clearly the Bank was putting some pressure on the Company and its guarantors to repay the loan. Mrs Mathews says that she and Mr Mathews agreed to sell the property at 24 Bayview Avenue to provide money to discharge the Bank's debt. It was clear that all the net proceeds of that sale would go to pay the Company's indebtedness as well as certain other personal debts of Mr and Mrs Mathews to the Bank. Mrs Mathews gave the following unchallenged evidence as to what was discussed between herself and Mr Mathews: "I recall I was very upset at having to sell the Hyams Beach Property, not only because my grandmother would not have wanted it (and in fact I didn't ever tell her that it sold prior to her passing), but also because I wasn't going to receive any money from the sale, given that all of the available proceeds would be repaid to the CBA and the other parties. In this regard, I recall having a conversation with Craig to the following effect: SM: 'Craig, I was hoping to receive some money out of the sale of this property. Everything is going to the bank and I am going to be left with nothing.' CM: 'We have to pay the money to the CBA and Swiss Commercial for the vendor finance for Swiss Joinery, as they hold mortgages over the property. CBA want the money repaid in respect of the facility we took out for Indian Pacific Interiors. It's okay, we will make sure that the money coming out of the sale which is paid to the CBA is ultimately noted as being a loan by you to Indian Pacific Interiors, which will be repaid in priority to any other debts which the company might have. You will be repaid.'" 8 On 12 July 2007 the sale of 24 Bayview Avenue was completed. Mr and Mrs Mathews' solicitor directed the purchaser to provide a bank cheque on settlement for $858,818.73 in favour of the Commonwealth Bank. That cheque was received by the Commonwealth Bank on 13 July 2007. $500,000 out of that amount was used to discharge in full the Company's liability to the Bank and the remainder was used to discharge the several personal liabilities of Mr and Mrs Mathews to the Bank. 9 Some time after 13 July 2007 – the date is not clear from the evidence – an accountant dealing with Mr and Mrs Mathews' affairs entered into the Company's general ledger as at 13 July 2007 a loan of $500,000, the creditor being shown as "Craig Matthews Family". 10 There is no evidence that the terms of this entry were in accordance with the direct instructions of either Mr or Mrs Mathews. The evidence in fact suggests that the entry was made as a temporary means of recording a liability of the Company until the accounts could be prepared on a more detailed and informed basis. 11 On 27 June 2008 the Company was placed in voluntary administration. On 2 July 2008 the Bank executed a deed of assignment in favour of Mrs Mathews alone whereby it assigned to her the equitable mortgage and floating charge which had been given by the Company on 17 July 2005. 12 On 10 July 2008 Mrs Mathews appointed the Defendant as Receiver of the Company under the provisions of the deed of equitable mortgage. The Administrator concedes that if Mrs Mathews was entitled to the benefit of the equitable mortgage, an event of default had occurred by the time that she exercised the power to appoint the Receiver, namely, the Company had been placed in administration, so that the appointment would be valid. However, the Administrator says that Mrs Mathews was not entitled to the benefit of the deed of equitable mortgage. He says that the assignment of the security by the Bank to Mrs Mathews of 2 July 2008 was invalid for two reasons. 13 Mr Golledge of Counsel, who appears for the Administrator, concedes that if the characterisation of the transaction which occurred on 13 July 2007 was that Mrs Mathews, as guarantor of the Company's debt to the Bank, discharged the Company's debt out of her own monies, then she would be entitled in equity to be subrogated to the Bank's security and would, even without the deed of assignment of 2 July 2008, have been entitled to appoint the Receiver when she did. 14 However, Mr Golledge says the true characterisation of the transaction which occurred on that day was that Mr and Mrs Mathews lent to the Company itself the sum of $500,000 which then became the Company's money and that the Company itself then discharged its liability to the Bank, so that this is not a case of a guarantor discharging the obligation of the principal debtor, and the equitable doctrine of subrogation does not arise. 15 Second, Mr Golledge says that if the Company's debt was not discharged out of its own monies, then it was discharged out of monies jointly owned by Mr and Mrs Mathews, so that they were jointly entitled to the subrogated security of the Bank and could exercise the rights conferred thereunder only jointly and not separately. He says that the appointment of the receiver by Mrs Mathews alone is therefore invalid. 16 I am unable to accept either submission. 17 As to the characterisation of the transaction, it is clear from the evidence of Mrs Mathews, which I accept, that neither she nor Mr Mathews have any legal knowledge and that they did not obtain advice as to the legal consequence of what they proposed to do by the transaction which they effected on 13 July 2007. They were under pressure to discharge their own obligations as guarantors of the Company and thereby under pressure to procure the Company itself to discharge its obligations to the Bank. They sold a jointly owned property and they directed that the settlement cheque be drawn, not in honour of the Company itself but, rather, to the Company's creditor, that is, the Bank. 18 There is nothing in the evidence which compels the conclusion that they intended the payment to be a loan to the Company rather than a discharge of the Company's obligation to the Bank by themselves as guarantors. As I have noted above, the entry in the Company's general ledger was not made on their instructions. 19 Mr Golledge points to a letter sent by Mrs Mathews solicitors on 4 July 2008. It is a letter directed to the Administrator in support of the assertion that Mrs Mathews was entitled to appoint a Receiver under the equitable mortgage. The letter states: "We are instructed that on or around 13 July 2007, it was agreed between our client and the Company that our client would discharge in full the existing loan/bill facility held by the Company with the Commonwealth Bank of Australia (CBA) . In consideration for this loan to the Company by our client, our client was to be granted an assignment of the fixed and floating charge (Charge) which the CBA held over the assets of the Company. In this regard, we are instructed that our client discharged the CBA facility on or around 13 July 2007, upon our client's receipt of sale proceeds arising from the sale of certain land held by her at 24 Bayview Avenue, Hyams Beach. We enclose documentation in support of said payment for your attention." 20 Mr Golledge emphasises that in that letter Mrs Mathews' solicitors say that it had been agreed between Mrs Mathews and the Company that there would be a loan by Mrs Mathews to the Company. First, I do not think the evidence supports such an agreement. Second, I do not think that this is the proper construction of the letter. 21 The letter states that the agreement was that Mrs Mathews would discharge in full the liability of the Company with the Bank, not that Mrs Mathews would lend the Company the sum of $500,000. The reference in the remainder of the paragraph to "a loan to the Company" is merely a way of reflecting, in a shorthand fashion, the fact that, by reason of Mrs Mathews' discharge, as guarantor, of the Company's debt to the Bank, Mrs Mathews herself became, in law, a creditor of the Company. 22 In any event, as I have said previously, the legal implications of the transaction were not discussed or even understood between Mr and Mrs Mathews prior to effecting the transaction on 13 July 2007. In my view, the characterisation of the transaction is one which the law itself gives in the circumstances of this case. Where guarantors, out of their own property, procure the payment of a guaranteed debt directly to the creditor rather than putting the money into the hands of the debtor, the transaction is one whereby the guarantors, and in compliance with their obligations under the guarantee, have discharged the debtor's obligations to the creditor and thereby have the benefit of the equitable doctrine of subrogation. 23 I deal now with the second point raised by Mr Golledge, that is, that the benefit of equitable subrogation to the Bank's security was conferred jointly, so that the power to appoint a receiver under that security could not be exercised by Mrs Mathews alone. 24 In my view, the conversations recounted by Mrs Mathews which I have set out above indicate very clearly an agreement between Mr and Mrs Mathews that Mrs Mathews alone was to have the benefit of a first security over the Company's assets in consideration of her agreeing that a particular property, which was in Mr Mathews' name through no financial contribution on his part, was to be sold and the proceeds used to discharge the Company's liability. 25 The agreement between the parties was that Mrs Mathews alone would be responsible for discharging the obligations to the Bank secured by the mortgage over 24 Bayview Avenue, and that Mr Mathews alone would be responsible for discharging liabilities arising otherwise in relation to the business of the Company and probably other businesses conducted by him as well. In other words, both parties acknowledged the Bank's debt would be discharged out of property which they regarded as Mrs Mathews', by moral obligation if not legal obligation. 26 Later, when the parties were considering the application of the proceeds of sale of 24 Bayview Avenue they agreed further that Mrs Mathews would be entitled, as between themselves, to first priority over the assets of the Company for repayment of the money which she had made available to discharge the Company's debts out of the proceeds of sale of 24 Bayview Avenue. 27 It is true that they did not expressly agree that Mrs Mathews would be a first-ranking secured creditor in so many words. This is understandable in view of the fact that neither of them had any legal qualification or had received any legal advice. It is true also that they did not discuss expressly the means by which Mrs Mathews alone would be entitled to the benefit of a first-ranking security over the Company's assets. However, the law provided that, absent any agreement to the contrary, Mr and Mrs Mathews would be jointly entitled in equity to the Bank's subrogated security. In the conversations which I have recounted, Mr Mathews was agreeing that the benefit which he would otherwise enjoy jointly with Mrs Mathews would be exercisable by Mrs Mathews alone and for her sole benefit. 28 That this was the true intention of the parties is supported, I think, by the fact that later, when the Bank came to execute a formal assignment of the equitable mortgage, it did so in favour of Mrs Mathews alone. I infer that, but for the agreement between Mr and Mrs Mathews recounted by Mrs Mathews, Mr Mathews would have insisted upon his own right to participate in the benefit of that security. However, the Bank's assignment to Mrs Mathews alone is in conformity with the agreement between Mr and Mrs Mathews that it would be Mrs Mathews alone who would have the right to exercise a security over the Company's assets to repay herself from the proceeds of sale of the Bayview Avenue property which she had made available to discharge the Company's liability. 29 In my opinion, that agreement between Mr and Mrs Mathews was enforceable in equity. It was not in writing, but it did not need to be in writing because the interest being transferred was not an interest in real estate but, rather, an equitable right to exercise a security. 30 In my view, therefore, as at 2 July 2008, and as at indeed 13 July 2007, Mrs Mathews alone was entitled in equity to exercise by way of subrogation the security right of the Bank conferred by the deed of equitable mortgage. The deed which was later executed by the Bank in July 2008 conferred upon her no more than a right to which she was already entitled in equity as at 13 July 2007. 31 In those circumstances it is clear, in my opinion, that the exercise of the right of appointment of a receiver by Mrs Mathews on 10 July 2008 was valid. 32 The Originating Process will therefore be dismissed. 33 I order that the Plaintiff pay the Defendant's costs of the Originating Process. – oOo – 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. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.