|Focus:||Donnelly (Trustee) v Windovel Pty Limited  FCA 80|
|Services:||Dispute Resolution & Litigation, Financial Services|
|Industry Focus:||Financial Services|
Issuing proceedings to recover assets of a bankrupt estate on the basis that a transfer prior to bankruptcy was made with the intention to defeat creditors, is often fraught with difficulty.
The most obvious hurdle is establishing the requisite intention of the bankrupt, sometimes years prior to a sequestration order. Another common issue is whether the intention to defeat also applies to impending creditors as well as actual creditors. The recent case of Donnelly (Trustee) v Windovel Pty Limited1 looks at the law in this area and is a helpful reminder that perseverance sometimes pays dividends.
In September 2008, Mr Bonnell became bankrupt by a sequestration order, following the issue of a creditor's petition by the Commissioner of Taxation.
Ten years earlier, the Bankrupt had obtained a private ruling from the then Assistant Commissioner of Taxation so that contributions to his personal non-complying superannuation fund were tax deductible (private ruling).
Following the private ruling, the Bankrupt set up a personal non-complying super fund for the purpose of making contributions and claiming tax deductions. He also set up his own taxation advice business and marketed these schemes to clients. Over the next eight months, he earned several million dollars from assisting clients with structuring their taxation affairs in accordance with the private ruling.
Between March and May 1999, the Commissioner of Taxation issued media releases stating that the tax office would withdraw a range of private rulings, and that schemes of the kind marketed by the Bankrupt were considered contrived arrangements intended to frustrate the clear policy of tax legislation and, therefore, were unlawful.
Following the media releases, the Bankrupt made contributions to his non-complying super fund in the amount of five million dollars. He then wound up the super fund and distributed all of the fund's assets to himself as beneficiary. The Bankrupt thereafter gifted the sum of five million to his family trust.
Following his bankruptcy nine years later, the bankruptcy trustee issued proceedings under section 121 of the Bankruptcy Act 1966 (Cth)2 (Act) claiming that the transfer of funds by the Bankrupt to the trustee of his family trust was void against the trustee. The trustee claimed that the transfer was made with the intention to put the amount beyond reach of his creditors, or was otherwise made at a time when the bankrupt was insolvent or about to become insolvent.
What was the 'main purpose' of the transfer?
To be successful in an action under section 121(1), the trustee must prove that the transferor's 'main purpose' in making the transfer was to prevent, hinder, or delay the creditors getting a share of the property transferred. Proving what a person's main purpose was at some time in the past can often be a difficult task.
In resolving the issue, the Court would need to make a determination regarding the Bankrupt's requisite state of mind at the time of the transfer. The process of discerning the true purpose and intent of the Bankrupt involves assessing the direct evidence they give as to their state of mind against the objective indications of that state of mind, based on all the known facts at the time that the transfer of assets occurs.
In this case, the Bankrupt claimed that he made the gift as a basic and general asset protection strategy. He denied making the transfer to place it out of the reach of his creditors, as to his mind he had no substantial creditors at the time, and did not consider that the Commissioner would become a creditor.
While he admitted in cross-examination that he was aware of the media releases issued by the Commissioner, he formed the view that the arrangements covered by the media releases extended far beyond the schemes in which he was involved.
Further, despite there being documents in evidence authored by the Bankrupt which among other things, demonstrated that he knew that an assessment for millions of dollars was coming, the Bankrupt endeavoured to disown these views in cross-examination, explaining them as having been expressed at a time when he was under great stress.The Court considered his evidence as unintelligible and lacking credibility.
The Court relied on the High Court authority of Trustees of the Property of Cummins (A Bankrupt) v Cummins 3, for the proposition that in s121(1), the term "creditors" encompasses future creditors and is not confined to those persons who at the time of the relevant transfer have claims susceptible to a proof. The relevant debt need not be due and owing as at that date – it is sufficient if it is impending.
Based on the evidence, the Court was satisfied that the Bankrupt knew that there was a real possibility that the Commissioner of Taxation would disallow the contributions made to the fund and that if the contributions were not legitimately claimable, he would be liable to the ATO for approximately $2,425,000 in tax. On this basis, it was clear that the bankrupt's 'main purpose' in the transfer was to put the money out of reach of his creditors, namely the ATO.
Was the Bankrupt insolvent or about to become insolvent?
In establishing the main purpose of a transfer under section 121(1), a trustee can be assisted by section 121(2) of the Act which provides that a transferor is deemed to have the necessary purpose if it can be reasonably inferred that, at the time of the transfer, the transferor was, or was about to become, insolvent. Section 121(2) requires the Court to look objectively at the financial position of the transferor at the time of the transfer.4
In this case, the Court accepted the bankruptcy trustee's contention that the Bankrupt deliberately set upon a course of action which rendered him insolvent by making himself susceptible to a significant tax assessment (including penalties and interest), and deliberately divesting himself of the only funds he had available to meet that assessment.
Therefore, the Court was satisfied that the bankruptcy trustee could also rely upon s121(2) in order to prove that the bankrupt had the requisite main purpose as specified in s121(1).
Some of the key take aways from this case are:
- As opposed to an alleged undervalued transaction under section 120 of the Act (which allows a trustee to have relation back to a period up to five years before the date of bankruptcy), there is no relation back period in respect of transactions alleged to be undertaken with the intent to defeat creditors.
- Future or impending creditors can be taken into consideration in establishing the bankrupt's 'main purpose' of a transaction as well as in determining insolvency.
- The test to determine whether the main purpose of a transaction was to defeat creditors under section 121(1) is both objective and subjective. It requires a subjective assessment of the bankrupt's state of mind as at the date of the transfer against other objective indications of that state of mind (such as a consideration of all relevant facts which existed at the time of the transaction) in order to make a judgment as to the true position. Where it can be proved that the bankrupt was or about to become insolvent, section 121(2) provides that "the transferor's main purpose in making the transfer" is taken to be to defeat creditors.5
- Given much of the required evidence regarding the Bankrupt's intention and true purpose of the transaction in this case was elicited during cross-examination, bankruptcy trustees may wish to consider conducting a public examination of a bankrupt to determine the likely evidence available prior to commencing proceedings to recover assets said to have been intentionally put beyond the reach of creditors.
1 FCA 80.
2Section 121(1) states that a transfer of property by a person who later becomes a bankrupt is void against the bankruptcy trustee if the property would have formed part of the bankrupt's estate and the main purpose of the transfer was to prevent, hinder or delay the property becoming divisible amongst the bankrupt's creditors. Section 121(2) states that the transfer will be taken to be for the purpose of defeating creditors if it can reasonably be inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent.
3(2006) 227 CLR 278.
4Ashton v Prentice  FCA 1464.
5Prentice v Cummins (No 5) (2002) 124 FCR 67 at 95.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.