Unfair preferences, third-party payments and the Quistclose trust

If you are a creditor trying to collect a debt from a possibly insolvent client or customer, it is in your interest to know that in December 2017 the Full Court of the Federal Court confirmed that there are circumstances in which a creditor who receives a payment that would otherwise be an unfair preference, will not have to refund that payment to a trustee in bankruptcy if the payment is made by a third-party and the funds never became the property of the bankrupt.

The issue

We know that money received in payment of a debt in the six months before bankruptcy proceedings are started may have to be repaid to the debtor’s trustee in bankruptcy, if the payment had the effect of giving the creditor a preference, priority or advantage over other creditors.

This can include a payment received from a third-party, if the funds used to make the payment were actually the property of the debtor. For example, if B owes money to A, and A directs B to pay the money instead to C, who is a creditor of A, it is the same as if A had received payment himself or herself, and A had made the payment to C.

In Rambaldi (Trustee) v Commissioner of Taxation, in the matter of Alex (Bankrupt) the Full Court identified at least one, and probably two, ways in which you can avoid this result.

The case

Briefly, the relevant facts in Rambaldi were these:

• On 18 March 2014 the Deputy Commissioner of Taxation filed a creditor’s petition (ie commenced proceedings to make the debtor bankrupt) against Ms Alex.

• On 1 June 2014 Ms Alex entered into an agreement with a third-party by which the third party agreed to lend Ms Alex the money to pay the debt owed to the Deputy Commissioner.

• The agreement specified that the loan could only be used for the payment of the debt owed to the Deputy Commissioner, and that the third-party’s cheque for the loan would be drawn in favour of the Deputy Commissioner.

• In due course the third-party provided a bank cheque (issued by the Commonwealth Bank of Australia) drawn in favour of the Deputy Commissioner to Ms Alex, who deposited it at a post office for the credit of the Deputy Commissioner on 7 July 2014.

• On 8 December 2014 Ms Alex was made bankrupt by order of a Federal Circuit Court Judge.

The Deputy Commissioner accepted that the effect of the transaction was to give him a preference, priority or advantage over other creditors of Ms Alex, and that the transaction occurred during the relevant period.

However the Deputy Commissioner argued that either:

• the payment was not a transfer of property by Ms Alex, or

• that it was property held by Ms Alex on what is known as a “Quistclose trust” (which arises where money is loaned for the sole purpose of paying a specific debt), and so never became her property and was not recoverable by the trustees.

The trustees in bankruptcy claimed that the payment to the Deputy Commissioner was a transfer of property by Ms Alex because:

• she borrowed the money from the third-party and directed the third-party to pay to the Deputy Commissioner;

• the third-party procured the bank cheque in favour of the Deputy Commissioner and provided it to Ms Alex;

• Ms Alex gave the bank cheque to the Deputy Commissioner in payment of the amount owed by her; and

• this amounted to acquisition of the legal title to the bank cheque (or the money represented by the bank cheque) by Ms Alex, and the transfer of that legal title to the Deputy Commissioner.

The trustees maintained that on the basis of a previous case that it did not matter whether the bank cheque was held on trust or not.

The judgment

The Full Court agreed with the Deputy Commissioner that there had been no transfer of property by Ms Alex.

The Court held that there was no point at which ownership of the bank cheque, or the funds represented by it, passed to Ms Alex. It was acquired by the third-party, drawn upon the relevant bank and was payable to the Deputy Commissioner.

Ms Alex never became entitled to the money. There was no basis for inferring that Ms Alex had anything more than possession of it for a limited purpose.

Nor could the agreement to borrow from the third-party by Ms Alex and subsequent payment to the Deputy Commissioner be viewed as a payment by direction of her money. Her indebtedness arose because of the third-party’s payment of its money to the Deputy Commissioner. The most she had was a contractual right, enforceable against the third-party, for the payment to be made. That right was not transferred to anybody else, including the Deputy Commissioner.

What about the Quistclose trust argument?

Because the funds passed directly to the Deputy Commissioner, no trust came into effect, and the Full Court did not have to determine what the position would have been if a Quistclose trust had existed.

However the Full Court took the opportunity to review the case law on Quistclose trusts and observed that the correctness of the decision of the House of Lords from which this type of trust derives its name, and the reasoning in support of that decision, have been widely accepted for almost 50 years in addition to the long history preceding the Quistclose decision.

What does the decision mean for you?

The important take away is that if you are a creditor trying to collect a debt from a possibly insolvent client or customer, and you want to avoid having to refund that payment to a trustee in bankruptcy if the debtor becomes bankrupt not long after you receive payment, you would be wise to insist on payment by a third-party, out of funds that belong to the third-party, and that do not come through the bank account of your debtor.

If the arrangement is properly documented, you should still be protected even if the third-party’s funds are received via the bank account of the debtor, because you will be the beneficiary of a Quistclose trust.

A note of caution

The case relied upon by the trustees to say that it did not matter whether a Quistclose trust existed or not, was a case concerning a corporate insolvency.

The Full Court distinguished the case on the basis that the corresponding provisions of the Corporations Act 2001 are relevantly different to those of the Bankruptcy Act 1966 that apply to personal insolvency, and also on its facts.

There nonetheless remains some doubt, in a corporate insolvency context, as to whether a Quistclose trust will provide the same protection as it will in the bankruptcy context.

How we can help

Bartier Perry can help you to negotiate an arrangement that protects you as far as legally possible from unfair preference claims, and can ensure that the arrangement is properly documented.

If you receive an unfair preference claim from a trustee in bankruptcy or a liquidator, we can provide advice, insight and representation.

Author: David Creais