New South Wales Supreme Court CITATION : McGrath v WorkCover WA [2010] NSWSC 384 This decision has been amended. Please see the end of the judgment for a list of the amendments. HEARING DATE(S) : 28/04/10 JUDGMENT DATE : 6 May 2010 JURISDICTION : Equity Division Corporations List JUDGMENT OF : Barrett J DECISION : Application for declaratory relief dismissed. CATCHWORDS : CORPORATIONS - winding up - winding up by the court - winding up of insurance company where Commonwealth insurance law makes assets in Australia primarily applicable to meet liabilities in Australia - scheme of arrangement binding on liquidator, creditors and contributories contains provision in like terms - meaning of "assets in Australia" - where company in liquidation enters into litigation funding agreement as funder - money being "assets in Australia" expended in providing funding thereunder - where agreement provided in certain eventuality for payment to company of sum outlaid, interest thereon and a share of net proceeds of litigation - whether third of these elements is part of "assets in Australia" - postulated concept of "new value" Corporations Act 2001 (Cth), ss 411(4), 543, 588FF Employers' Indemnity Supplementation Fund Act 1980 (WA) LEGISLATION CITED : Insurance Act 1973 (Cth), S 116(3) Uniform Civil Procedure Rules 2005 , rule 7.6(1)(c) Workers' Compensation and Injury Management Act 1981 (WA). CATEGORY : Principal judgment AssetInsure Pty Ltd v New Cap Reinsurance Corporation Ltd [2004] NSWCA 225; (2004) 61 NSWLR 451 AssetInsure Pty Ltd v New Cap Reinsurance Corporation Ltd [2006] HCA 13; (2006) 225 CLR 331 Commissioner of Taxation v Betro Harrison Constructions Pty Ltd (1978) 37 FLR 150 CASES CITED : New Cap Reinsurance Corporation Ltd v Faraday Underwriting Ltd [2003] NSWSC 842; (2003) 47 ACSR 306 Re Federal Building Assurance Co Ltd [1932] VLR 301 Re HIH Casualty and General Insurance Ltd [2005] NSWSC 240; (2005) 215 ALR 562 Re National Employers' Mutual General Insurance Association Ltd (1995) 15 ACSR 624 PARTIES : Anthony McGrath and Christopher Honey in their capacity as scheme administrators of HIH Casualty and General Insurance Limited (In Liq) (Subject to Scheme of Arrangement) - Plaintiffs WorkCover WA - Defendant FILE NUMBER(S) : SC 2010/104992 COUNSEL : Mr M B Oakes SC - Plaintiffs Mr S T White SC- Defendant SOLICITORS : Blake Dawson - Plaintiffs WorkCover WA - Defendant IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST BARRETT J THURSDAY 6 MAY 2010 2010/104992 ANTHONY McGRATH & ANOR IN THEIR CAPACITY AS SCHEME ADMINISTRATORS OF HIH CASUALTY AND GENERAL INSURANCE LTD (IN LIQUIDATION) (SUBJECT TO SCHEME OF ARRANGEMENT) v WORKCOVER WA JUDGMENT 1 The plaintiffs are the "scheme administrators" of a scheme of arrangement which, by virtue of an order made under s 411(4) of the Corporations Act 2001 (Cth) in 2006, became binding on the creditors, the liquidators and the contributories of HIH Casualty and General Insurance Ltd ("C&G"), a company in the course of winding up by the court. 2 By force of the scheme of arrangement, creditors of C&G came to have rights created by the scheme itself in place of their entitlements to prove in and receive dividends from the winding up of C&G. The scheme created an alternative regime for the administration of assets available in the winding up and application of those assets towards claims cognisable in the winding up. 3 The plaintiffs, as the administrators of the scheme, have come to a view about the correct treatment of a particular asset under the scheme provisions. But because a contrary view is available and they wish to be on firm ground, the scheme administrators have filed a summons seeking declaratory relief supporting the treatment they advocate. 4 The defendant named in the summons is WorkCover Western Australia Authority ("WorkCover WA"), a body corporate continued in existence by the Workers' Compensation and Injury Management Act 1981 (WA). By virtue of the Employers' Indemnity Supplementation Fund Act 1980 (WA), WorkCover WA assumed the obligations of C&G to meet claims in respect of workers' compensation upon the insolvency of C&G. As a result, WorkCover WA is a creditor of C&G in the sum of $47,261,394.25. 5 In the course of the hearing of the summons, I made an order pursuant to rule 7.6(1)(c) of the Uniform Civil Procedure Rules 2005 appointing WorkCover WA to represent all scheme creditors of C&G whose claims are "Liabilities in Australia" as defined by the scheme. 6 This order was made to ensure that a proper contradictor is party to an application in which the scheme administrators themselves press for declaratory relief that would benefit scheme creditors other than those whose claims are "Liabilities in Australia". A representative of the class that would suffer detriment if the declaratory relief were granted is necessary as defendant to ensure that the application for declaratory relief is appropriately constituted, it obviously being impracticable to join as parties all creditors with claims that are "Liabilities in Australia". 7 The question at the centre of the claim for declaratory relief concerns the operation of scheme provisions which, as it were, re-enact s 116(3) of the Insurance Act 1973 (Cth), as in force at the commencement of C&G's winding up on 27 August 2001: "In the winding up of a body corporate authorized under this Act to carry on insurance business, or in the winding up of a supervised body corporate, the assets in Australia of the body corporate shall not be applied in the discharge of its liabilities other than its liabilities in Australia unless it has no liabilities in Australia." 8 The question is whether certain money received by C&G pursuant to a litigation funding agreement under which it provided financial accommodation are within the meaning of the scheme's definition of "Asset in Australia". 9 Relevant provisions of the scheme of arrangement are clauses 33 and 34: "33. Non-Reinsurance Assets in Australia 33.1 Assets in Australia that are not distributed in accordance with clause 31.1 are to be applied by the Scheme Administrators in the following order: (a) first, in payment of any Established Scheme Claim or Scheme Cost that is a Priority Claim, and to the extent that such a priority comprises: (i) a Scheme Cost incurred by the External Administrators, they are to be such Scheme Costs incurred by the External Administrators as are fairly apportioned by the Scheme Administrators to be paid from those assets; and (ii) an Established Scheme Claim, such claim must be a Liability in Australia; and (b) secondly, in payment of all Liabilities in Australia, with such Established Scheme Claims ranking at residual amounts after the deduction of any amounts received in accordance with clauses 31 or 32 or pursuant to any Section 562A(4) Order, pro rata. 33.2 For the purposes of this clause 33: (a) payments of Priority Claims shall be made in accordance with the order of priorities given in sections 556 and 562 of the Corporations Act; and (b) Priority Claims of a class referred to in the order of priorities as set out in clause 33.2(a) and Established Scheme Claims shall rank equally between themselves and must be paid in full, unless the Property of the Scheme Company is insufficient to meet them, in which case they must be paid proportionately. 33.3 Any Assets remaining after the application of this clause 33 will be included in the assets to be distributed in accordance with clause 34. 34. Non-Reinsurance Assets which are not Assets in Australia 34.1 Scheme Assets that are not assets which are distributed in accordance with clauses 31.1, 32.1, 33.1 or 35.1 are to be applied by the Scheme Administrators in the following order: (a) first, in payment of any Established Scheme Claim or Scheme Cost that is a Priority Claim, including Scheme Costs incurred by the External Administrators which are not paid under clauses 31, 32, 33 or 35; (b) secondly, in payment of all Established Scheme Claims other than Liabilities in Australia, with such Established Scheme Claims ranking at residual amounts after the deduction of any prior amounts received in accordance with clause 32 or any Section 562A(4) Order, until the same percentage payment made in respect to the Liabilities in clause 33.1(b) has been achieved, pro rata; and (c) thirdly, in payment of all Established Scheme Claims, with such Established Scheme Claims ranking at residual amounts after the deduction of any amounts received in accordance with clauses 31 and 32 or pursuant to any Section 562A(4) Order, pro rata. 34.2 For the purposes of this clause 34: (a) payments of Priority Claims shall be made in accordance with the order of priorities given in sections 556 and 562 of the Corporations Act; and (b) Priority Claims of a class referred to in the order of priorities as set out in clause 34.2(a) and Established Scheme Claims shall rank equally between themselves and must be paid in full, unless the property of the company is insufficient to meet them, in which case they must be paid proportionately. 34.3 Any assets remaining after the application of this clause 34 will be applied in the following order: (a) first, in accordance with clauses 38.10 and 38.11; and ((b) secondly, to be paid to the Liquidators." 10 These two clauses are the third and fourth of five provisions which direct application of particular classes of assets and, between them, deal with the totality of assets. The classes not dealt with by clauses 33 and 34 are Reinsurance Assets that are Assets in Australia (clause 31), Reinsurance Assets that are not Assets in Australia (clause 32) and US Trust Fund Assets (clause 35). The provisions with respect to those classes may be left to one side as irrelevant for present purposes. 11 By virtue of a definition clause 1.1, "Asset in Australia" means "A Scheme Asset which is an 'asset in Australia' within the meaning of section 116(3) of the Insurance Act on the Record Date and any Scheme Asset which has been converted into another form (cash or otherwise) after the Record Date shall be treated for the purposes of determining whether it is an 'asset in Australia' as having the character which the Scheme Asset had at the Record Date;" 12 Other relevant definitions are: "Scheme Asset all assets of a Scheme Company whether actual, prospective or contingent; for the avoidance of doubt, this expression shall include any asset which is held or recovered for the benefit of a Scheme Company or its creditors by the Liquidators;" "Insurance Act Insurance Act 1973 of the Commonwealth of Australia as in force at the Record Date;" 13 The "Record Date" is 27 August 2001, being, as I have said, the date of commencement of C&G's winding up. 14 The litigation funding agreement was entered into by C&G on 2 November 2005, that is, several months before the scheme came into effect but several years after the "Record Date". The question is whether a particular sum received under the agreement is within the scheme's definition of "Asset in Australia". If it is, it will be applied under clause 33 for the benefit of creditors (including Workcover WA) to whom "Liabilities in Australia" are owed. If it is not, it will be applied under clause 34 for the benefit of creditors to whom liabilities other than "Liabilities in Australia" are owed. The scheme administrators contend that the sum falls outside the "Asset in Australia" definition. 15 I turn to the agreement of 2 November 2005. C&G was a party to that agreement and was designated a "Funder". It undertook to provide financial accommodation (by way of cash outlay) to allow two of its related companies (also in liquidation) to prosecute legal proceedings that had been commenced by them as plaintiffs in this court. 16 The agreement of 2 November 2005 made provision with respect to any moneys recovered by those plaintiff companies in the proceedings, whether through judgment or through compromise. Those moneys are referred to in the agreement as "Proceeds". Clause 7.1 of the agreement provided: "Subject to clause 7.3, the Proceeds will be distributed in the following order of priority: (a) first, payment to each Funder and each Past Funder of an amount equal to the Funding and Security for Costs paid in accordance with clause 7.3(a); (b) next, payment of Interest to each Funder and each Past Funder in accordance with clause 7.3(b); and (c) next, payment of the Funders' Premium to the Funders in accordance with clause 7.3(c) and payment of the Plaintiffs' Balance to the Plaintiffs in accordance with clause 7.4." 17 Clause 7.3 made provision for the division of "Proceeds" among several "Funders". It is not necessary to refer further to that clause. 18 In substance, the structure of the agreement was such that a Funder was, as against the plaintiff companies, contractually entitled to receive out of the plaintiffs' "Proceeds", first, reimbursement of the Funder's outlay in providing the agreed financial accommodation in the first place, second, a sum equivalent to interest on that outlay at a specified rate for the period of the accommodation and, third, the particular Funder's share of the sum designated "Funders' Premium", being a stated proportion of net proceeds derived by the plaintiff companies from the litigation. Net proceeds were to be struck after the first two elements had been met out of gross proceeds, with the result that there would be net proceeds out of which "Funders' Premium" only if gross proceeds exceeded all funders' accommodation and the interest element applicable thereto. 19 In the events that happened, C&G, having made financial accommodation available under the agreement, received not only return of its initial outlay and the agreed interest element but also its share of "Funders' Premium". The present application concerns the third of those elements, that is the substantial sum of money that was C&G's share of the "Funders' Premium". 20 In addressing the question whether C&G's share of the "Funders' Premium" was an "Asset in Australia" for the purposes of the scheme, it should be recorded that all parties to the funding agreement were Australian residents; that the agreement was expressed to be governed by the law of New South Wales; and that the parties submitted to the jurisdiction of the courts exercising jurisdiction in New South Wales. All payments under and pursuant to the agreement were made in Australia in Australian currency. There is accordingly no suggestion that sums received under the funding agreement did not have territorial or geographical characteristics consistent with their being within the "Asset in Australia" definition. 21 Counsel for the liquidators referred to a number of authorities concerning approaches to be taken to the construction of a Part 5.1 scheme of arrangement which is, of course, a statutory construct binding by statute and for that reason distinguishable from a contractual compact reflecting the intention of contracting parties. Particular reference was made to the observation of Bowen CJ in Commissioner of Taxation v Betro Harrison Constructions Pty Ltd (1978) 37 FLR 150 that the effect of such a scheme of arrangement depends not on the perceived intentions of parties but on the proper construction of the scheme provisions themselves. 22 In seeking to determine the status of the part of the "Funders' Premium" received by C&G, one must focus first on that aspect of the definition of "Asset in Australia" in the scheme that adopts the statutory meaning. I refer, of course, to the words "which is an 'asset in Australia' within the meaning of section 116(3) of the Insurance Act on the Record Date". The words "within the meaning of" do not direct attention to any relevant definition or explanation of "asset in Australia" in s 116(3) or elsewhere in the Insurance Act as in force on 27 August 2001. The Act contains no such definition or explanation. It uses the words "assets in Australia of the body corporate" without explanation or elaboration, leaving the words to bear their ordinary meaning in the context in which they are used in the legislation. That, however, leads one to consider a small body of case law to which it will be necessary to turn in due course. First, however, an important point must be noted. 23 The scheme administrators accept (as does WorkCover WA) that the moneys expended by C&G in fulfilling its contractual commitment to provide financial accommodation to the plaintiff companies to assist them pursue the funded litigation formed part of C&G's assets in Australia for the purposes of the Insurance Act. It is also common ground that the first and second elements mentioned at paragraph [16] above – that is, moneys by way of reimbursement or repayment of the financial accommodation extended to the plaintiff companies and the sum representing interest on those moneys – were, when received, "assets in Australia" for the purposes of the legislation. 24 I mention these matters (and, in particular, the second of them) to emphasis that neither party espouses the view that "assets in Australia" in the statutory sense (or "Asset in Australia", as defined by the scheme) became, as it were, frozen in identity at the conclusion of 27 August 2001. Each side accepts that some process of tracing is permissible so that, to quote an example canvassed in the course of submissions, if there was, at the conclusion of 27 August 2001, an asset consisting of a credit balance with Bank A and those funds were, on 28 August 2001, withdrawn from Bank A and deposited with Bank B, the credit balance with Bank B, even though it did not exist as a chose in action against Bank B on 27 August 2001, would nevertheless be part of "assets in Australia" on 27 August 2001. Under the scheme's definition of "Asset in Australia", tracing is obviously contemplated by the express reference to conversion. 25 In the same way, the liquidators accepted (as did WorkCover WA) that if cash on hand at the conclusion of 27 August 2001 was, at some later time, invested in trustee investments as permitted by s 543, those investments would themselves be "assets in Australia" even though not held at 27 August 2001. Likewise where a debt was owed to the company but not due on 27 August 2001 and proceeds were later received, those proceeds would partake of the quality of the debt. 26 The scheme's "Asset in Australia" definition, by basing itself squarely on the statutory concept, includes notion of tracing that the parties accept as part of the statutory concept. The defined term is therefore not constrained by the specific concept of conversion mentioned in it. If the statutory concept embodies some wider notion of tracing or transmogrification, that notion applies for the purposes of the scheme's definition. 27 This leads me to the case law concerning s 116(3) of the Insurance Act. The decided cases of greatest relevance to the meaning of "assets in Australia" are a decision of 29 March 2005 in relation to C&G's then proposed scheme of arrangement (Re HIH Casualty and General Insurance Ltd [2005] NSWSC 240; (2005) 215 ALR 562) and the first instance decision of Windeyer J in the course of litigation concerning New Cap Reinsurance Corporation Ltd that culminated in a decision of the High Court of Australia in April 2006: see New Cap Reinsurance Corporation Ltd v Faraday Underwriting Ltd [2003] NSWSC 842; (2003) 47 ACSR 306 (Windeyer J), AssetInsure Pty Ltd v New Cap Reinsurance Corporation Ltd [2004] NSWCA 225; (2004) 61 NSWLR 451 (Court of Appeal) and AssetInsure Pty Ltd v New Cap Reinsurance Corporation Ltd [2006] HCA 13; (2006) 225 CLR 331 (High Court). 28 Although only the first instance decision in the New Cap litigation addressed the meaning of "assets in Australia", one question in relation to s 116(3) received a consistent answer at all stages. I refer to the question of the time at which "assets in Australia" and "liabilities in Australia" are to be identified. Given that s 116(3) is concerned with the application of assets in a winding up, it was accepted that the assets and liabilities in question are those at the commencement of the winding up. In the decision of 29 March 2005, I said (at [135]): "In New Cap Reinsurance , it was held by Windeyer J and confirmed by all members of the Court of Appeal that the effect of s 116(3) is to create in creditors at the commencement of the winding up a right to have their claims dealt with in a manner complying with s 116(3). The section thus operates upon assets in Australia at the time of winding up." 29 The High Court later endorsed that approach. The reference in the scheme's definition of "Asset in Australia" to the specific date 27 August 2001 is explicable on the basis of the approach thus approved. 30 The matter of returns on or accretions to assets existing at the commencement of the winding up was referred to by Windeyer J in the s 116(3) context as follows (at [39]): "So far as interest is earned on the proceeds of the realisation of assets in Australia at the date of liquidation is concerned, the position is not so clear. The answer should be the same for any income producing asset or account. For instance a real estate investment property earning rent should be treated in the same way as a bank account earning interest. In Re Federal Building Assurance Co Ltd [1932] ALR 324 ; [1932] VLR 301, there was under consideration s 448 of the Companies Act 1928 (Vic) which is the forerunner of s 116(3). It seems to have been assumed in that case that interest on assets in Victoria was part of the Victorian assets in respect of which payment of liabilities in Victoria was to be made in priority to payment of other liabilities. That view also seems to have been accepted in Re National Employers Mutual General Insurance Association Ltd (1995) 15 ACSR 624 , though in neither case was interest earned after the date of the commencement of the winding up specifically referred to, but against that no payments in one case in respect of liabilities outside of Victoria or in the other liabilities outside Australia was allowed. It must be assumed that interest was earned on the Victorian or Australian assets at the commencement of the winding up which would lead to the conclusion that if Australian assets are in the first place to satisfy Australian liabilities then the fruit of those assets should also be available for that purpose." 31 The effect of s 116(3), it seems to me, is to direct the creation of a distinct fund to be applied in the first instance in discharging particular liabilities (see the 29 March 2005 judgment at [136]). The initial composition of the fund is fixed at the commencement of the winding up but it is artificial and impracticable to regard it as subject to some requirement of static immutability, so that any subsequent change in the form of some part of it causes that part to be eliminated from the fund. 32 It is understandable and, in my respectful opinion, correct that, in Re National Employers' Mutual General Insurance Association Ltd (1995) 15 ACSR 624, McLelland CJ in Eq should have assumed that s 116(3) extended to "proceeds of recovery and realisation of assets of the company in Australia". Likewise, the decision of Cussen ACJ in Re Federal Building Assurance Co Ltd [1932] VLR 301 on analogous State legislation proceeded on the apparent footing that where, at the commencement of the winding up in 1931, a sum of £5,000 had been on deposit with the State Treasurer, assets of "between £5,700 and £5,800 made up mainly of the principal sum of £5,000 (and interest thereon) received by the liquidators from the Treasurer" were, in 1932, assets in Victoria primarily charged with the payment and satisfaction of liabilities in Victoria. 33 Once it is accepted that the effect of s 116(3) is that a particular geographically identified fund of assets is constituted at the commencement of the winding up and committed to the discharge of a particular geographically identified collection of liabilities cognisable in the winding up, it becomes easy, in my view, to accept that proceeds of, accretions to and returns on the components of the fund become part of the fund itself. 34 That is not to say, however, that everything satisfying the geographical test that comes into a liquidator's hands in the course of administration of the estate will form part of the fund. An example of money received in Australia from sources in Australia but falling outside the "assets in Australia" concept is the proceeds of liquidators' recovery actions under s 588FF and s 588M. Those sections cause to arise upon and by virtue of the winding up a right for the liquidator to obtain an order for the payment of money to the company. The company itself has, at the commencement of the winding up, no relevant item of property and the receipt by the company of money pursuant to such an order does not represent the realisation or transposition of any asset in Australia or a return on or accretion to any such asset. The position is as described by Windeyer J at [38]: "Such recoveries are not assets in Australia at the date of commencement of winding up as meant by s 116 of the Insurance Act. If a successful claim is made by a liquidator then the proceeds of such claim will be paid to the company in accordance with the general scheme of s 588FF. The claim is nevertheless a claim by a liquidator after commencement of the winding up. It may bring into existence the funds in Australia available for distribution, but that does not make the claim an asset of the company at winding up. The rights of the liquidator to recover funds for the company are statutory rights and not proprietary rights in the company at the date of the commencement of the winding up: N A Kratzmann Pty Ltd (in liq) v Tucker (No 2) (1968) 123 CLR 295 ; [1986] ALR 616; SJP Formwork (Aust) Pty Ltd (in liq) v DCT (2000) 34 ACSR 604 ; Tolcher v National Australia Bank Ltd (2003) 44 ACSR 727 ." 35 Mr Oakes SC, who appeared for the scheme administrators, relied upon a concept of "new value". He classified recoveries under, for example, s 588FF as such "new value". The liquidators submit that the "Funders' Premium" to which the present application relates is of the same character. The "Funder's Premium", it is said, does not represent a change in the form of a previously existing asset forming part of a fund constituted at the time of commencement of the winding up. 36 The liquidators say that the applicable test is one of "equivalence in substance". I see no basis for importing or implying any such test. If, consistently with s 543, a liquidator invested pre-existing cash assets in the purchase of marketable securities which, over the time they were held, quadrupled in value, the very substantial increase in value would not somehow contradict the reality that the marketable securities represented merely a conversion of the pre-existing cash into a different form and an asset into which that cash could be traced. 37 In the present case, it seems to me, there is simply no basis for differentiating between the second and third elements referred to at paragraph [16] above. The return in the nature of interest on the sum committed as financial accommodation is not different in nature from the return in the form of "Funders' Premium". C&G outlaid a particular sum which, it is accepted, was an "Asset in Australia" for the purposes of the scheme. The outlay caused to arise in C&G a contractual right to the three items referred to at paragraph above. There was, at that point, a conversion, as it were, of the cash into the contractual right. And when the contract was performed and the three items were paid to C&G, there was a conversion, in the same sense, of the contractual right into the proceeds received by reason of that performance. 38 The amount received by C&G as "Funders' Premium", having territorial characteristics mentioned at paragraph [20] above, is part of C&G's "assets in Australia" for the purposes of s 116(3) and accordingly an "Asset in Australia" as defined by the scheme arrangement. 39 It follows that the scheme administrators' claim for a declaration to the contrary effect must be dismissed. ********** 07/05/2010 - Typo - Paragraph(s) 21 - intention 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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