FEDERAL COURT OF AUSTRALIA

Katingal Pty Ltd v Amor [1999] FCA 317

CORPORATIONS – leave to sue company in liquidation - allegation (grounded on breach of fiduciary duty by founder and shareholder of company) of constructive trust over the whole of the business of the company – whether such a constructive trust excludes rights of creditors – nature and incidents of a constructive trust over a business – application dismissed.

Corporations Law, s 500(2)

Vagrand Pty Limited v Fielding (1993) 41 FCR 550 referred to

Re Sydney Formworks Pty Ltd (In Liq) (1965) 82 WN (Pt 1) (NSW) 558 referred to

Ogilvie-Grant v East (1983) 1 ACLC 742 referred to

Meehan v Stockmans Australian Cafe (Holdings) Pty Ltd (1996) 22 ACSR 123 applied

Executive Director of the Department of Conservation and Land Management v Ringfab Environmental Structures Pty Ltd (Lee J, unreported, 6 November 1997) applied

Attorney-General for Hong Kong v Reid [1994] 1 AC 324 distinguished

Beatty v Guggenheim Exploration Co (1919) 122 NE 378 applied

Hospital Products Limited v United States Surgical Corporation (1984) 156 CLR 41 applied

Daly v The Sydney Stock Exchange Limited (1986) 160 CLR 371 applied

Muschinski v Dodds (1985) 160 CLR 583 applied

Warman International Limited v Dwyer (1995) 182 CLR 544 applied

Consul Development Pty Limited v D.P.C. Estates Pty Limited (1975) 132 CLR 373 applied

United States Surgical Corporation v Hospital Products International Pty Ltd [1983] 2 NSWLR 157 applied

KATINGAL PTY LIMITED & ORS v BARRY CHARLES AMOR & ORS

NG 3178 of 1991

Burchett J

26 March 1999

Sydney

THE COURT ORDERS THAT:

            The motion for leave be dismissed with costs.

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

REASONS FOR JUDGMENT

1                     This is a motion brought by the applicants, pursuant to s 500(2) of the Corporations Law, for the leave of the Court to proceed with the action against the fifth respondent Australasian Memory Pty Limited (Australasian Memory) after the passing of a resolution for its voluntary winding up.

2                     It is not necessary to rehearse the details of the complex and lengthy history of this matter and of the factual basis of the claims made by the applicants.  What is essential for present purposes can be stated succinctly.  The claim made against Australasian Memory is that it is the creature of the first respondent, Mr Amor, who, in breach of fiduciary duties owed to the third applicant, Flexible Manufacturing Systems Pty Limited (Flexible), transferred to it the benefit of business opportunities, goodwill and other assets of Flexible.  A business involving the distribution of computers and related products was thus established, it is said, as the business of Australasian Memory, in flagrant disregard of the duty Mr Amor owed to Flexible, of which he was manager and a director.  He and the third respondent were the shareholders in Australasian Memory.  The case thus sought to be made out was expressed by the applicants’ solicitor in the following terms:

“The core of the claim here is that the assets of [Australasian Memory] are held on trust exclusively for the Applicants and are therefore not available to be shared between the Applicants and the creditors of [Australasian Memory] at all.”

This claim is made on the footing of a constructive trust of the entire business of Australasian Memory.  Alternatively, the constructive trust is alleged to have extended to part of that business, but the alternative was not put in argument in terms that disclosed any precise basis on which the business could be divided, and in substance, the claim was that the business of Australasian Memory was founded on breaches of fiduciary duty so as to be liable to the making of a declaration by the Court of a constructive trust in favour of Flexible.

3                     The resolution for the voluntary winding up of Australasian Memory was passed on 24 March 1997.  It was reported that the affairs of the company showed an estimated deficiency of 6.4 million dollars.  There are some 45 employees, who are priority creditors, to whom there is owing $176,385-97.  After payment of the priority creditors, the evidence is that unsecured creditors “will be entitled to only a very small dividend.”  Quite obviously, pursuit of the present action against Australasian Memory, if I grant leave, must deplete the relatively small sum available to the liquidator even further.

4                     The exercise of the discretion conferred on the Court by s 500(2), and other provisions of the same kind in various statutes dealing with the winding up of companies, has been the subject of consideration in numerous cases, of which it is sufficient to cite the following:  Vagrand Pty Limited v Fielding (1993) 41 FCR 550; Re Sydney Formworks Pty Ltd (In Liq) (1965) 82 WN (Pt 1) (NSW) 558; Ogilvie-Grant v East (1983) 1 ACLC 742; Meehan v Stockmans Australian Cafe (Holdings) Pty Ltd (1996) 22 ACSR 123; Executive Director of the Department of Conservation and Land Management v Ringfab Environmental Structures Pty Ltd (Lee J, unreported, 6 November 1997).  In the last case, Lee J said:

“S 500(2) of the Corporations Law requires the leave of the Court to be obtained before an action may be commenced against a company in liquidation.  The purpose of such a provision is to prevent a company in liquidation being subjected to actions that are expensive and, therefore, carried on at the expense of the creditors of the company and, perhaps, unnecessarily … .

In determining whether leave should be granted, the Court considers whether the balance of convenience lies in allowing the applicant to proceed by way of action to judgment, or whether the applicant should be left to pursue his claim by lodging a proof of debt with the liquidator.  The matter is one of discretion and the onus is on the applicant to demonstrate why it is more appropriate, in respect of a particular claim, to proceed by way of action … .

For leave to be granted, it must be shown that there is a serious or substantial question to be tried … .  Leave will not be granted where the applicant does not have a genuine claim or where the claim would be futile.”

In Meehan v Stockmans Australian Cafe (Holdings) Pty Ltd at 128, it was made clear that a reason for refusing leave would exist in a case where the resources available to the company were relatively meagre and the cost of a hearing, if leave were granted, would be quite considerable.

5                     What the applicants called their “core” case depends on the correctness of one proposition.  The proposition is that if the business of Australasian Memory was founded on breaches of fiduciary duty, with the consequence that it was held upon constructive trust for the applicants, their proprietary right in its assets overrides all claims of creditors, including priority creditors.  Unless this contention can be made good, a claim to beneficial ownership of the business will be worth nothing, since the business was worth nothing, its debts far exceeding its assets.  In my opinion, the proposition, if correct, would have extraordinary consequences.  The beneficial owner of a business carried on by an express trustee is not entitled to terminate the trust and claim the assets of the business free of all business debts.  He must accept that the business held in trust for him has creditors whose claims must be met before a balance can be struck.  Why should not the same be true when a constructive trust is imposed upon a business which has for some time been carried on so as to incur debts owed to innocent third parties?  Of course, third parties who were well aware of the breaches of fiduciary duty which underlay the business may be in a precarious position, but it is not suggested that the general body of creditors of Australasian Memory fell into any such category as this. 

6                     The applicants placed heavy reliance on the decision of the Privy Council in Attorney-General for Hong Kong v Reid [1994] 1 AC 324, where it was held that a fiduciary who is the recipient of a bribe holds the bribe, and any property representing the bribe, in trust for the injured person.  Lord Templeman said (at 333):

“If in law a trustee, who in breach of trust invests trust moneys in his own name, holds the investment as trust property, it is difficult to see why a trustee who in breach of trust receives and invests a bribe in his own name does not hold those investments also as trust property.”

In reaching this conclusion, his Lordship made clear (at 331) his advertence to the possibility that, in a particular case, where a false fiduciary becomes insolvent, “unsecured creditors of the false fiduciary will be deprived of their right to share in the proceeds of that property”.  He responded to this difficulty:

“But the unsecured creditors cannot be in a better position than their debtor.  The authorities show that property acquired by a trustee innocently but in breach of trust and the property from time to time representing the same belong in equity to the cestui que trust and not to the trustee personally whether he is solvent or insolvent.”

7                     The fact that moneys impressed with a constructive trust because received as a bribe, or real estate subject to the same trust because purchased by the use of the proceeds of bribery, when once abstracted from the assets of the trustee, will not be available to the trustee’s personal creditors, does not involve the consequence that a business, viewed as a complex asset, should be able to be divided in such a way that the beneficial owner may take out of it everything of value, leaving the creditors of the business without remedy.  This is the consequence for which the applicants contend.

8                     The applicants’ argument overlooks the flexibility of the remedy which equity provides when it imposes a constructive trust.  Long ago, in Beatty v Guggenheim Exploration Co (1919) 122 NE 378 at 381, Cardozo J said:

“A court of equity in decreeing a constructive trust is bound by no unyielding formula.  The equity of the transaction must shape the measure of relief.”

This passage was quoted with approval by Mason J in Hospital Products Limited v United States Surgical Corporation (1984) 156 CLR 41 at 108.  When the Court comes to consider what the “equity of the transaction” requires, the judgment of Gibbs CJ (with whom Wilson and Dawson JJ agreed) in Daly v The Sydney Stock Exchange Limited (1986) 160 CLR 371 at 379-380 suggests the Court may take account of the fact that the imposition of a constructive trust “could lead to consequences unjust both to the creditors of [a fiduciary in breach of his duty] and the [fiduciary] itself”.  Not only may this factor influence the decision whether to give the remedy of constructive trust; the judgment of Deane J in Muschinski v Dodds (1985) 160 CLR 583 at 615 makes it clear that the same consideration may lead to the moulding of relief of that nature, if given, in such a way as to avoid injustice to third parties.  Deane J there said:

“Indeed, in this country at least, the constructive trust has not outgrown its formative stages as an equitable remedy and should still be seen as constituting an in personam remedy attaching to property which may be moulded and adjusted to give effect to the application and interplay of equitable principles in the circumstances of the particular case.  In particular, where competing common law or equitable claims are or may be involved, a declaration of constructive trust by way of remedy can properly be so framed that the consequences of its imposition are operative only from the date of judgment or formal court order or from some other specified date.”

It was on this basis that his Honour concluded (at 623):

“Lest the legitimate claims of third parties be adversely affected, the constructive trust should be imposed only from the date of publication of reasons for judgment of this Court.”

Deane J’s approach was strongly endorsed by the Cambridge academic A J Oakley in his article The Precise Effect of the Imposition of a Constructive Trust published in Equity and Contemporary Legal Developments (edited by S Goldstein, 1992) at 437-438, 455-456.  Thus, too, in Warman International Limited v Dwyer (1995) 182 CLR 544 at 559, where an account of profits was in question, the joint judgment of the judges of the High Court states:

“It is necessary to keep steadily in mind the cardinal principle of equity that the remedy must be fashioned to fit the nature of the case and the particular facts.”

More directly relevant to the present case are the remarks of Gibbs J in Consul Development Pty Limited v D.P.C. Estates Pty Limited (1975) 132 CLR 373 at 395, where his Honour said:

“The question whether the remedy which the person to whom the duty is owed may obtain against the person who has violated a duty is proprietary or personal may sometimes be one of some difficulty.  In some cases the fiduciary has been declared a trustee of the property which he has gained by his breach; in others he has been called upon to account for his profits and sometimes the distinction between the two remedies has not, it appears, been kept clearly in mind.”

This passage in the judgment of Gibbs J was referred to by the Court (Moffitt P, Hope and Samuels JJA) in the decision of the Court of Appeal in United States Surgical Corporation v Hospital Products International Pty Ltd [1983] 2 NSWLR 157 at 213, where their Honours said:

“Commonly the profits in respect of which an account is ordered are of an income nature, but in appropriate circumstances they may be of a capital nature.  As was pointed out by Gibbs J in Consul (at 395), and as appears clearly enough in Keech [Keech v Sandford (1726) Sel Cas Ch 61; 25 ER 223], the remedy of declaring the fiduciary a trustee of property which he has gained by his breach is to be distinguished from an order for an account of his profits.  However the questions as to which of these forms of relief is appropriate, or whether both are appropriate, or whether some other form of relief such as an injunction or a lien is appropriate, must await, inter alia, an identification of the gain.”

In the same case, their Honours had said (at 212):

“The description of the fiduciary’s gain will not always, although often it will, identify the remedy which will be available to the beneficiary, but undoubtedly it will be most relevant in determining what remedy he should have.”

9                     In my opinion, in a case where it is suggested a constructive trust should be imposed in respect of a business, the identification of the fiduciary’s gain is crucial.  It is that gain which should be delivered up to the beneficiary, as rightful owner.  Where the fiduciary’s disloyalty has led to the establishment of a business, the gain is plainly not its gross assets without any allowance for the debts it has incurred; the gain must be the net worth of the business.  That is what the fiduciary has disloyally obtained for himself, and that is the true subject of any remedial constructive trust.  At all events, any gain achieved through the business has been so achieved, at least in part, as a result of the business receiving the benefit of its dealings with innocent third parties.  Upon the principle, which is described in Story:  Commentaries on Equity Jurisprudence (1884) sec 64e as “of no small extent”, that “he who seeks equity must do equity” (see also Snell’s Equity (29^th ed, 1990) at 30-31), the beneficiary should not be permitted to reap the rewards of the business done with those third parties, except upon the footing of meeting the claims arising out of their transactions entered into in the course of the business without notice of his rights.

10                  This view of the true scope of the equitable relief which may be available in such a case receives support from a leading text and in academic writings.  In Jacobs’ Law of Trusts in Australia (6^th ed by R P Meagher and W M C Gummow, 1997) at para 1332 it is stated:

“Where a trust of a business undertaking is held to be the appropriate remedy, a question arises concerning third parties who have dealt innocently with the defendants while the business was being established in breach of duty.  If they purchase the legal title to assets without notice, then no difficulty arises.  But what, for example, of a financier who has lent money on equitable security over the assets of the business?  If he does so with knowledge, or dishonestly, then he may not only lose any priority but himself become accountable on the second (if not the first) limb of Barnes v Addy (1874) LR 9 Ch App 244.  But what if he is innocent?  When does the trust arise in favour of the plaintiff?  Does the first equitable interest in time prevail?  These are questions as yet unanswered by authority.  One answer would be that as the money lent went into building up the business, the whole undertaking cannot represent the gain from the breach of duty to the plaintiff.  The response might be that but for the breach, there would have been no business to offer as security for the borrowing.  A further answer may be that in such a case, the merits are unequal so that the equity first in time (that of the fiduciary’s principal) need not prevail (Heid v Reliance Finance Corp (1983) 154 CLR 326 at 341-2 per Mason, Deane JJ) or that it should prevail only upon the principal accepting conditions which make allowance for the later equity.  …  Another possibility is to treat the constructive trust not as an institution which arises when the facts calling for it take place, but as a remedy available only which may operate from the date of judgment or formal court order or from some other specified date as suggested by Deane J in Muschinski v Dodds.  A decree might then be drawn so as to accommodate the equity of the equitable charge.”

See also Cope:  Constructive Trusts (1992) at 294.  The same point is taken up in an extra-judicial article by Kearney J (then a judge of the Supreme Court of New South Wales) entitled Accounting for a Fiduciary’s Gains in Commercial Contexts, published in Equity and Commercial Relationships (edited by P D Finn, 1987), in the remarks (at 201):

“An allied question arises as to priorities as between the beneficiary under a trust declared of a business and third parties who acted innocently in dealing with the fiduciary conducting the business in breach of duty.  A litany of questions is posed in Jacobs’ Law of Trusts in Australia.  The position of the equitable chargee, particularly under a floating charge, springs to mind immediately, together with the conceptual analysis of constructive trust as an institution or as a remedy.  An answer which avoids these problems is that the proper approach is … to identify the business undertaking as a whole, comprising both assets and liabilities.  Hence, it could be said that the beneficiary under a trust declared of such an enterprise must take the benefit with the burden.  This approach would seem to produce a result consonant with equity’s regard to the conscience of a person such as an innocent creditor who may be affected by the granting of equitable relief.  By analogy, the constructive trust takes effect as an institution ab initio as between beneficiary and fiduciary, but as a remedy from the time of granting relief as against the innocent third party.”

In an article R P Austin:  Constructive Trusts published in Essays in Equity (edited by P D Finn, 1985) at 240, it is pointed out that “a proprietary remedy should not ever be regarded as mandatory.  It should be possible for a court to exercise a discretion against decreeing proprietary relief if the circumstances suggest that it would be unwise to do so.”  The alternative remedy of an account of profits is proposed. 

11                  In my opinion, there is no doubt that the applicants’ core contention ought not to be accepted.  This is very plainly a case in which a proprietary remedy would not be granted to the applicants in a form that would override the just claims of creditors.  That conclusion destroys the foundation on which the applicants’ motion was based.  There were alternative claims pleaded against Australasian Memory, but these were not elaborated in argument.  In any case, I am not persuaded that there is any reason why, if they are to be pursued, they should not be the subject of claims put forward to the liquidator in the normal way. 

12                  Accordingly, the motion for leave is dismissed with costs.

Associate:

Dated:              26 March 1999