The Victorian Court of Appeal recently allowed an appeal against an order staying a proceeding brought by companies in liquidation against their former directors for knowingly assisting breaches of trust allegedly committed by the companies. The Court discussed the principles that operate in such circumstances.

Nicholson Street Pty Ltd (receivers and managers appointed) (in liq) v Letten [2016] VSCA 157

Nicholson Street v Letten [2016] VSCA 157 is the latest chapter in a large, long-running insolvency. In 2010, ASIC successfully applied to the Federal Court (Gordon J) for the winding-up of a number of commingled and unregistered managed investment schemes. Receivers were appointed to a number of corporate entities. Because of the irretrievable intermingling of assets and funds, pooling orders were made. In 2011, on ASIC’s application, the receivers were appointed as liquidators of, among others, the three corporations that would become plaintiffs in this proceeding, commenced in the Supreme Court of Victoria.

At the centre of this corporate collapse were two individuals: Mark Letten and Paul Lane. Both were directors of the plaintiffs.

Following directions to the receivers/liquidators from Gordon J (ASIC v Letten (No 7) [2010] FCA 1231), the plaintiffs sued Letten and Lane in the Supreme Court for knowingly assisting the plaintiffs in breaches of trust: otherwise known as a second-limb Barnes v Addy claim.

It is a confronting state of affairs: a wrongdoer is seeking to recover from its helpers the losses caused by its own wrongdoing.

Judd J stayed the proceeding until further order because “some transparently independent party [was required to represent] the interests of the beneficiaries”. Even though his Honour accepted the proposition that the receivers/liquidators remained subject to the supervision of the Federal Court, his Honour justified the result as follows ([2015] VSC 583, [44]):

The plaintiffs have chosen a litigation path that requires proof of their own dishonesty. While it is true that they had no independent mind, intention or purpose other than the mind, intention and purpose of at least one of the defendants, the objective observer might reasonably conclude that in the absence of some transparently independent party representing the interests of the beneficiaries, their interests will be at risk. In the absence of an alleged common dishonest and fraudulent design, perpetrated by the plaintiffs and assisted by the defendants, the requirement for an independent representative of the beneficiaries may not be so compelling. But for so long as the plaintiffs maintain their case based on the second limb of Barnes v Addy, I am of the opinion that the interests of the beneficiaries must be transparently protected.

The Court of Appeal (Whelan and Ferguson JJA, Kaye JA agreeing) allowed an appeal from that decision.

It was common ground that the law was as stated by Brooking J, in the Full Court of the Supreme Court of Victoria, in Young v Murphy [1996] 1 VR 279, 281-5. Whelan and Ferguson JJA said that:

Gordon J observed that Brooking J had indicated that a distinction was to be drawn between proceedings which sought to get back a trust fund and proceedings for the execution or administration of the trust; the former may be maintained by the trustee without joining beneficiaries and the latter may be incapable of being so maintained. Gordon J concluded that the proposed claim was ‘directed at restoring the trust fund’.

In the decided cases, a New Zealand decision was analogous: Marshall Futures Ltd v Marshall [1992] 1 NZLR 316. In that case, a liquidator caused a company to sue former officers of the company for knowingly assisting the company in breaches of trust. Tipping J said:

In the present case [the trustee] has since the events in question gone into liquidation and it is now under the control of a liquidator. Although in strictly analytical terms it is the same legal entity as it was when the allegedly fraudulent breaches of trust occurred, the hands controlling it now are those of the liquidator and not those of the directors. There cannot be any suggestion that the liquidator’s hands are unclean. In substance the liquidator, through the vehicle of the company, is suing on the first cause of action for the benefit of the clients of [the trustee] whose funds have been lost. I agree that at first blush it may appear a little bizarre that the nominal plaintiff is asserting its own fraudulent breach of trust as part of its cause of action against its officers.

Their Honours said they agreed “with the view that he expressed that a court is entitled to look to the practical reality of who is bringing the claim when assessing whether a trustee plaintiff can properly represent the interests of beneficiaries” ([78]).

Their Honours said that Brooking J’s articulation of the relevant principles was properly understood as follows ([76]):

Brooking J’s analysis reveals that a trustee can sue to redress a breach of trust even if the trustee was itself guilty of misconduct and committed, or was a party to, the relevant breach of trust. ‘In general’ in such proceedings the trustee need not make the beneficiaries a party because ‘in general’ the trustee sufficiently represents their interests. But while that is the position ‘in general’, the beneficiaries or representatives should be made parties if their interests may not be properly represented by the trustee. This position may arise ‘for any reason’. Fraud or collusion or a hidden interest are obvious circumstances which might (not must) lead to a conclusion that a trustee could not properly represent the interests of beneficiaries. An obvious example would be a second limb Barnes v Addy claim where there was a continuing connection or association between the alleged assisters and those controlling the claimant trustee. More generally, if the proceeding raises issues of potential controversy between the beneficiaries themselves or between the beneficiaries and the trustee then the trustee may not be able to represent the beneficiaries’ interests properly. Thus, if a proceeding involves issues concerning execution or administration of the trust, in addition to seeking to redress a breach of trust, then beneficiaries or representatives may have to be joined. That is not ‘generally’ the position if the proceeding is confined to obtaining redress for a breach of trust. Accordingly, there is a distinction to be drawn between a proceeding concerning redress for a breach of trust, and a proceeding concerning execution or administration of the trust.

Kaye JA considered that “the test is practical, rather than conceptual” ([90]).

Put simply, whether a corporate plaintiff is permissibly prosecuting the claim in reliance on its own breach of trust depends on a practical analysis of the circumstances of the claim. If an independent person is in control of the corporate plaintiff (and one could imagine that new directors, rather than an external administrator, may fit that bill), then it can be expected that the litigation will not be stayed.

Judd J’s error was not in the identification of the correct principles, but the test that he actually applied. As observed by Whelan and Ferguson JJA, his Honour “concluded that a stay was required, not because he had found that the plaintiffs did not sufficiently represent the interests of the beneficiaries, but rather because an objective observer might reasonably conclude that in the absence of an independent party representing the beneficiaries their interests would be at risk” ([80]).

Further, in the circumstances of Nicholson Street, even if the test Judd J applied had been the correct one, it was not open to his Honour to conclude that the beneficiaries’ interests were at risk without an independent party joined to the proceeding. There would also have been practical difficulties associated with joining a party, including increased cost and complexity to the litigation.