The Full Court of the Federal Court of Australia handed down its judgment in Rambaldi (Trustee) v Commissioner of Taxation, in the matter of Alex (Bankrupt) [2017] FCAFC 217. Rambaldi provides several useful observations regarding unfair preference payment claims, specifically in regards to paying (tax) debts using money borrowed from third party lenders. In particular, the judgment comments on whether a creditor can successfully contend a Quistclose Trust to defeat unfair preference payment claims by trustees in bankruptcy (and by liquidators).

Although Rambaldi involves the payment of taxation debts in the context of individual bankruptcy, its reasoning applies equally to the payment of other unsecured debts by individuals. Moreover, several parts of the judgment speak to how similar facts may be treated in the context of corporate insolvency.

Facts

The bankrupt had a taxation debt due and payable to the Commissioner of Taxation. The bankrupt entered into a loan agreement with a third party lender. The loan agreement provided that the bankrupt must only use the loaned money for the purposes of paying her outstanding tax liabilities (and paying her legal representatives for services ancillary to same).

Critically, the third party lender drew the cheque in favour of the Commissioner rather than in the name of the bankrupt. The money never passed through the hands of the bankrupt. Rather, the bankrupt merely took physical possession of the cheque which was already drawn in favour of the Commissioner, and then deposited the cheque at a post office for credit of the Commissioner.

The parties’ arguments

The bankrupt trustees argued, amongst other things, that:

  1. the loaned money comprising the cheque was property which vested in the trustees because it was property acquired by the bankrupt after the date of her bankruptcy (see section 58(1) of the Bankruptcy Act 1966 (Cth)); and
  2. the money paid to the Commissioner was an unfair preference payment because it was a transfer of property which preferred the Commissioner over the bankrupt’s other creditors, such that the transfer was void against the trustees and could be recovered (see section 122(1) of the Bankruptcy Act).

The Commissioner in turn argued that there was no such transfer of property because the property (the money) never passed to the bankrupt. Alternatively, the Commissioner contended that the arrangement between the third party lender and the bankrupt gave rise to a QT, such that the money fell outside the bankrupt’s property divisible among creditors.

In this respect, to make good the QT argument, the Commissioner needed to satisfy the court that: there was a mutual intention between the lender and the bankrupt that the loaned money was only to be used for the agreed purpose (discharging the tax debt); and the loaned money was to be held on trust by the bankrupt for the benefit of the Commissioner, failing which, the bankrupt holds the money on trust for the benefit of the lender (often referred to as the ‘primary’ and ‘secondary’ trusts respectively).

The primary judge

The trial judge held that this case was on all fours with the leading QT judgment of Barclays Bank Ltd v Quistclose Investments Limited [1970] AC 567. The trustees sought to distinguish Quistclose on the basis that in that case the money actually passed into the hands of the debtor, whereas in this case, the moneys did not pass into the bankrupt’s hands (because she simply took physical possession of the already drawn cheque).

The primary judge rejected this argument, observing that the question was not whether there was a need for a trust at the time of payment, but rather, whether the parties intended there to be such a trust. Accordingly, the Commissioner successfully argued at trial that the money fell outside the bankrupt’s estate because the arrangement gave rise to a QT.

The appeal

On appeal, the Full Court, comprising Allsop CJ, Dowsett and Burley JJ, made the following observations and findings in its unanimous judgment:

  • The issue in this case was whether the bankrupt had transferred property (being the sum of $118,071.62) to the Commissioner, for the purposes of section 122(1) of the Bankruptcy Act.
  • There is a practical difference between the unfair preference payment regimes for individual bankruptcy and corporate insolvency contained in the Bankruptcy Act and the Corporations Act 2001 (Cth) respectively. This difference is that the unfair preference regime in the Bankruptcy Act refers to a ‘transfer’ of property (which prefers a creditor), whereas the Corporations Act refers to a ‘transaction’ (which prefers a creditor). In this respect, a ‘transaction’ may include many contractual or other arrangements apart from transfers of property, including tripartite or multi party arrangements.
  • The above distinction between the language adopted in the Bankruptcy Act and Corporations Act (i.e. transfer vs transaction) led the Full Court to reject the trustees’ reliance on Re Emanuel (No 14) Pty Ltd (in liq); Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281. Specifically, the trustees relied on Re Emanuel to argue that a finding that there was a QT is not necessarily inconsistent with a finding that there had been a transfer of property. To that end, Re Emanuel held that an unfair preference payment arises in corporate insolvency when a third party (C) pays an unsecured debt to B which was owed by A to B, if C’s payment to B had the effect of satisfying a separate debt due by C to A.
  • However, the Full Court held that such a transaction might well satisfy the unfair preference payments regime in the context of corporate insolvency, but is of no assistance in the case of individual bankruptcy, particularly as Re Emanuel focused on the language in the Corporations Act. That is to say, such a tripartite agreement may well be a ‘transaction’ which prefers the recipient creditor in the context of corporate insolvency.
  • Accordingly, the Full Court held that once it is accepted that the relevant property subject to the trustees’ claim was the sum of $118,071.62, any impugned transfer had to be of that amount. Consequently, it soon became clear that the trustees’ case was without merit because at no point did the funds pass to the bankrupt, and therefore the bankrupt could not have ‘transferred’ the money to the Commissioner. That is to say, the bankrupt did not receive property (money) from the lender and therefore made no transfer to the Commissioner.
  • Similarly, the Full Court held that a QT did not arise because such a trust can only arise if the funds pass into the hands of the bankrupt, which did not occur (i.e. no primary and secondary trust was created). Rather, the funds passed directly to the Commissioner, and so no trust came into effect because no legal or equitable interest in the property ever passed to the bankrupt (see paragraphs 40 and 43).

Practical tips

Although the judgment is relatively straightforward, reconciling the gaps (especially in the corporate insolvency space) is quite challenging. That said, our observations are as follows:

  • The reasoning in Rambaldi suggests that it may be possible for creditors to defeat an unfair preference claim by a trustee in bankruptcy on the basis that the money paid to the creditor by the bankrupt is subject to a QT, because it was advanced by a third party to the bankrupt for that limited purpose, failing which the money is to be returned to the lender. However, to sure up this position it is prudent to ensure that the loaned money is segregated from the bankrupt’s pool of general assets and that the parties’ intentions are expressed in writing.
  • Ironically, if the money advanced by a third party lender pursuant to a QT passes into the hands of the bankrupt before it is paid to a creditor, the creditor may lose the protection of Rambaldi’s reasoning, because the bankrupt would have to fall back on arguing that a QT exists. This ‘defence’ is likely supported by the older line of authorities relating to QT such as Toovey v Milne (1819) 2B & A 683, Australasian Conference Association Ltd v Mainline Constructions Pty Ltd (in liq) (1978) 141 CLR 335, and Quistclose, each of which held that property subject to a QT falls outside the bankrupt’s divisible assets. However, this is clearly not without its risks.
  • Accordingly, given the contemporary and authoritative nature of Rambaldi, it seems that it may be more prudent to simply have the third party lender draw the cheque in favour of the creditor and ensure that the money does not pass into the hands of the financially distressed individual.
  • In the case of corporate insolvencies, it is likely that the arrangements in Rambaldi would constitute a ‘transaction’ for the purposes of the unfair preference payment regime. This proposition is consistent with the line of authorities which interpret ‘transaction’ broadly, such as Re Emanuel, Commissioner of Taxation v Kassem and Secatore [2012] FCAFC 124, and Young & Anor v Commissioner of Taxation [2010] NSWSC 288.
  • Accordingly, in the case of financially distressed companies borrowing money from third party lenders, it is preferable for the third party lender to advance the money into a segregated account of the borrower and to document the mutual intention of the parties regarding establishing the primary and secondary trusts. That said, to our knowledge there are no judgments considering the application of a QT in the context of the language of section 588FA of the Corporations Act. In Gliderol International Pty Limited v Hall [2001] SASC 355, the Supreme Court of South Australia found that the evidence did not support the existence of a QT because the money advanced was not deposited into a segregated account, but rather, the general pool of assets. Accordingly, the court did not consider whether a QT could apply to defeat a liquidator’s claim in the context of section 588FA of the Corporations Act.

The judgment of Rambaldi can be found here:
http://www.judgments.fedcourt.gov.au/judgments/Judgments/fca/full/2017/2017fcafc0217