In the recent decision of Boensch as Trustee of the Boensch Trust v Scott Darren Pascoe [2019] HCA 49, the High Court has clarified whether property held by a bankrupt on trust for another vests in the bankrupt's trustee in bankruptcy, and the circumstances in which a trustee in bankruptcy will have reasonable cause to lodge a caveat to protect an interest in the trust property.

Background

Mr Franz Boensch and his wife Sabine were the registered owners as joint tenants of a property at Rydalmere, a suburb of Sydney in the state of New South Wales (Rydalmere property). Mr Boensch claimed that in 1999, after he and Ms Boensch had divorced, they executed a Memorandum of Trust wherein Ms Boensch agreed to transfer her interest in the Rydalmere property to Mr Boensch to hold on trust for their children (Boensch Trust).

In October 2003, Mr Boensch was served with a bankruptcy notice.

Mr Boensch claimed that on 17 March 2004, he and Ms Boensch as settlors executed a Deed of Trust in relation to the Boensch Trust prepared by solicitors. On 21 March 2004, Mr and Mrs Boensch executed a Transfer of their estate in the Rydalmere property to Mr Boensch.

A caveat forbidding the registration of any instrument not in accordance with the Boensch Trust was recorded on the title on 17 August 2005.

On 23 August 2005, a sequestration order was made against Mr Boensch and Mr Scott Pascoe was appointed as Mr Boensch's trustee in bankruptcy. Later that day, Mr Pascoe received advice from counsel that there were strong prospects of defeating the claim that Mr Boensch held the Rydalmere property on trust (by demonstrating that the Boensch Trust was a sham) or, alternatively, of having any trust set aside (as a transfer of property made to put the property beyond the reach of Mr Boensch's creditors).

On 25 August 2005, Mr Pascoe lodged a caveat on the title to the Rydalmere property. In accordance with his usual practice, he claimed a "Legal Interest pursuant to the Bankruptcy Act 1966".

Commencing from September 2005 various solicitors acting for Mr Boensch sought to persuade Mr Pascoe to remove the caveat that he had lodged over the Rydalmere property (including by threatening to file a lapsing notice), without success.

By November 2005 Mr Pascoe had formed the view that, even if Mr Boensch's trust claims were valid, Mr Boensch was likely to have a trustee's right of indemnity out of the Boensch Trust assets.

In July 2006 Mr Pascoe commenced proceedings in the Federal Magistrates Court for a declaration that the Memorandum of Trust was void as against Mr Pascoe, and for relief under s 120 or alternatively s 121 of the Bankruptcy Act 1966 (Cth) in respect of the Deed of Trust and the Transfer dated March 2004. Those proceedings were unsuccessful as was a subsequent appeal to the Full Court of the Federal Court.

In August 2009 Mr Pascoe's solicitor was served with a lapsing notice. At that stage, Mr Pascoe considered that such interest as Mr Boensch may have in the Rydalmere property by virtue of his right of indemnity as trustee "would be of limited value". He therefore decided to let the caveat lapse.

Mr Boensch commenced proceedings in the Supreme Court of NSW seeking an order that Mr Pascoe pay compensation under s 74P(1) of the Real Property Act 1900 (NSW). Section 74P(1) provides that any person who, "without reasonable cause", lodges a caveat, or refuses or fails to withdraw such a caveat after being requested to do so, is liable to pay compensation to any person who sustains pecuniary loss attributable to the lodging of the caveat, or the refusal or failure to withdraw it.

Relevant statutory provisions

The word "property" is defined widely in s 5(1) of the Bankruptcy Act for the purposes of that Act as including "any estate, interest or profit, whether present or future, vested or contingent, arising out of or incident to any … real or personal property". Section 116(2)(a), however, provides the property of a bankrupt divisible among his or her creditors does not extend to "property held by the bankrupt in trust for another person".

Section 58(1) of the Bankruptcy Act provides that, subject to the Act, where a debtor becomes a bankrupt, "the property of the bankrupt" vests in the Official Trustee or any registered trustee who has become the trustee of the bankrupt's estate, either forthwith or as soon as the property is acquired by or devolves on the bankrupt.

Decisions of the NSW Supreme Court and Full Court of the Federal Court

The NSW Supreme Court held that, upon the making of a sequestration order against a bankrupt who holds property on trust, s 58(1)(a) of the Bankruptcy Act operates in equity to vest such property in the bankrupt's trustee in bankruptcy subject to the trust, and that the trustee in bankruptcy thereby acquires a caveatable interest in the property. It followed that, upon the making of the sequestration order against Mr Boensch, the Rydalmere property vested in equity in Mr Pascoe – thereby conferring a caveatable interest on Mr Pascoe.

Accordingly, because Mr Boensch had not proven that Mr Pascoe lacked a caveatable interest, it could not be said that Mr Pascoe had lodged or maintained the caveat without "reasonable cause" within the meaning of s 74P(1). In case that conclusion were wrong, the Court then went on to determine that if Mr Pascoe did not have a caveatable interest, he would nevertheless have had an honest belief based on reasonable grounds that he had a caveatable interest.

Mr Boensch appealed unsuccessfully to the Full Court of the Federal Court.

Mr Boensch was granted special leave to appeal to the High Court because the appeal raised a question of principle of general importance as to whether property held by a bankrupt on trust for another vests in the bankrupt's trustee in bankruptcy pursuant to s 58 of the Bankruptcy Act.

Decision of the High Court

The High Court unanimously dismissed Mr Boensch's appeal. In doing so the Court clarified the answer to the question of whether (and to what extent) trust property vests in a bankrupt's trustee in bankruptcy, being a question that the Full Court below had observed was "not free of difficulty".

Reading the above-mentioned statutory provisions together, the High Court observed that the key question is whether the bankrupt has a "contingent beneficial interest which is extant and valid" in the trust property, and if that question is answered in the affirmative, then upon the making of a sequestration order the property will pass to the bankrupt's trustee in bankruptcy, "subject to the equities in favour of third parties" to which it was subject in the hands of the bankrupt (at [91]).

The High Court noted that both the NSW Supreme Court and Full Court had failed to assess whether Mr Boensch had such a beneficial interest in the Rydalmere property. Rather, those Courts had approached the matter on the basis that the fact that Mr Boensch was the registered proprietor of the property at the time of commencement of his bankruptcy was sufficient to confer a caveatable interest in the property on Mr Pascoe. According to the High Court, this "overstated the position" (at [95]).

The High Court also confirmed that a bankrupt's vested or contingent beneficial interest in trust property sufficient for the property to pass to the bankrupt's trustee in bankruptcy "may arise either under the express terms of the trust or aliunde, including by reason of the bankrupt trustee's right to be indemnified out of the trust property for obligations incurred in the bankrupt's capacity as trustee" (aliunde meaning "from elsewhere" in Latin). Further, ordinarily the burden of proving the absence of such a beneficial interest is on the bankrupt (at [92]-[93]).

At first instance, Mr Pascoe pleaded that Mr Boensch had a valid beneficial interest in the Rydalmere property sufficient to give rise to a caveatable interest arising from Mr Boensch's right of indemnity. The relevant evidence included Mr Boensch's own admission that he had incurred significant expenses in his capacity as trustee for the Boensch Trust, in the form of "bank payments, loan payments, the council rates, [and] every other cost ... required" for the trust.

The High Court agreed with this argument, concluding at [102] that:

"By reason of that beneficial interest, an estate in the property vested forthwith in equity in Mr Pascoe pursuant to s 58 of the Bankruptcy Act 1966, subject to a subtrust on the terms of the Boensch Trust but permitting Mr Pascoe to exercise the right of indemnity … that was a sufficient basis to sustain his caveat".

On the other hand, the possibility that the Boensch Trust might have been set aside, and Mr Pascoe had commenced proceedings seeking the same, did not confer an interest sufficient to sustain the caveat (at [104]).

Finally, the High Court rejected the suggestion by Mr Boensch that Mr Pascoe had claimed "inconsistent interests" by justifying his lodgement and maintenance of the caveat on the basis of his alternative arguments that the Boensch Trust was void and that, were it not, Mr Boensch would enjoy a right of indemnity.

Takeaways

The judgment is an important one for practitioners in the bankruptcy area particularly given the prevalence of trusts in the modern world, including family discretionary trusts.

The answer to the question of whether to lodge (or refuse to withdraw) a caveat by the trustee of a bankrupt estate over trust property associated with the bankrupt is now clear. As the High Court observed at [105], "provided the caveat is lodged on the basis of an honest belief on reasonable grounds that the bankrupt has an extant beneficial interest in the property (including a beneficial interest by way of right of indemnity), the trustee in bankruptcy will be warranted in lodging a caveat, as Mr Pascoe did in this case".