Can you prefer one creditor by arranging a third party loan, the proceeds of which are paid directly to that creditor, without the arrangement being void against your trustee in bankruptcy? “Yes” says the Full Federal Court – thus confirming an important distinction between personal and corporate insolvency.

Rambaldi (Trustee) v Commissioner of Taxation, in the matter of Alex (Bankrupt) [2017] FCAFC 217

On 18 December 2017, the Full Court of the Federal Court (Allsop CJ, Dowsett and Burley JJ) dismissed an appeal by the joint trustees in bankruptcy of Athina Alex in Rambaldi (Trustee) v Commissioner of Taxation, in the matter of Alex (Bankrupt) [2017] FCAFC 217 (Re Alex).

The trustees had appealed the decision of North J that a payment received by the Australian Taxation Office (ATO) under an arrangement between the bankrupt and a third party, in part-satisfaction of a debt owed to the ATO by the bankrupt, was not void against the trustees as an unfair preference pursuant to s 122(1) of the Bankruptcy Act 1966 (Cth) (Rambaldi (Trustee) v Commissioner of Taxation, in the matter of Alex (Bankrupt) [2017] FCA 567)).

Why the decision matters

By refusing the appeal, the Full Court confirmed that an insolvent individual debtor may enter into a transaction with a third party that has the effect of giving one creditor a priority or advantage (over other creditors) without that transaction being void against the debtor’s trustee in bankruptcy as an unfair preference.

This may be contrasted with the position of the Full Court (decision discussed below) in relation to an insolvent corporate debtor under s 588FA of the Corporations Act 2001 (Cth).

The mechanism by which this was relevantly achieved in this case was for the debtor to obtain a loan from a third party, the proceeds of which were expressly agreed by the parties to be dealt with solely for a particular purpose (payment to the ATO) and for no other purpose. Additionally, payment was made directly by the third party to the ATO – without passing via the debtor.

The ‘Quistclose trust’

The argument before North J focused on whether the particular arrangement gave rise to a species of ‘Quistclose trust’ – so named after the decision of the House of Lords in Barclays Bank Ltd v Quistclose Investments Limited [1970] AC 567 – such that the loan funds would not be treated as forming part of the property of the bankrupt for the purposes of s 122(1).

In Quistclose, funds were advanced by a lender, Quistclose, for the specific purpose of the borrower using those funds to satisfy an obligation to pay a declared dividend. The express intention of the parties was that the funds advanced would not form part of the general assets of the borrower – but instead would to be applied solely in satisfaction of the dividend obligation. By agreement, the funds were deposited into a specific account of the borrower with Barclays Bank – separate from its other accounts with the bank. The borrower subsequently went into voluntary liquidation (before the dividend obligation could be satisfied). Quistclose successfully obtained relief in equity for recovery of the funds on the basis that the primary purpose for their advance had failed and that a resultant trust, in favour of Quistclose, arose (the bank had sought to retain the monies to be applied against amounts owing on the borrower’s other accounts with the bank).

By contrast, in Re Alex, the purpose for the advance by the lender to the debtor-borrower did not fail (i.e. the funds were successfully paid over to the ATO). In fact, the debtor, Ms Alex, never received the loan funds – by agreement between the parties, they were represented by a bank cheque, drawn against the lender’s account in favour of the ATO.

The argument on appeal

On appeal, the Commissioner argued that the funds represented by the bank cheque never became the property of Ms Alex – passing as they did directly from the lender to the ATO – therefore it was not necessary for the Full Court to conclude that the funds were impressed with any type of ‘Quistclose trust’.

The Commissioner further argued that, in any event, the authorities supported the conclusion that the funds would be impressed with a species of ‘Quistclose trust’, such that payment of them over to the ATO would not be a transfer of the property of the bankrupt for the purposes of s 122(1).

The Trustees argued that as the loan agreement provided for the payment of the loan funds to the ATO (i.e. a payment by direction) – the borrower was, in substance and effect, making a transfer out of funds which had been lent to her for that purpose.

The Trustees agreed that as the funds were paid directly to the ATO (on the instruction of the bankrupt), no species of ‘Quistclose Trust’ arose – but in any event, the existence or otherwise of a species of ‘Quistclose trust’ did not prevent the operation of s 122(1).

The Trustees relied on analogous reasoning of the Full Court in Re Emanuel (No 14) Pty Ltd (in liq); Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281; 24 ACSR 292 regarding the application of the provisions in s 588FA of the Corporations Law (as it then was) – concerning unfair preferences of a company in liquidation that were voidable transactions. Similar reasoning was also applied by the Full Court in relation to s 588FA of the Corporations Act 2001 (Cth) in Commissioner of Taxation v Kassem and Secatore [2012] FCAFC 124.

The Full Court’s decision

In dismissing the appeal, the Full Court rejected both of the Trustees’ arguments. In relation to the payment, the Full Court disagreed that the payment mechanism for settlement of the loan funds resulted in Ms Alex relevantly acquiring any property for the purposes of s 122(1). Further, as the funds passed directly to the ATO, no trust came into effect.

In the course of their reasoning, the Full Court emphasised the differences in wording between s 122(1) of the Bankruptcy Act and s 588FA (in its various forms). Hence presently a distinction remains in the law regarding unfair preferences and third-party payments in personal bankruptcy as compared to corporate insolvency.