FEDERAL COURT OF AUSTRALIA

Lovell v Penkin, in the matter of the bankrupt estate of Kevin Michael Penkin [2008] FCA 637

BANKRUPTCY AND INSOLVENCY – stay of claim in Supreme Court in negligence alone against a solicitor – application for leave to take a fresh step in the proceeding – granting of leave – imposing of conditions – whether leave is required in a claim in negligence alone against a solicitor – whether such a claim is provable in the bankruptcy – other considerations such as set-off – bilateral relationship – s 117 of the Bankruptcy Act 1966 (Cth) and the availability of insurance

Bankruptcy Act 1966 (Cth) ss 58, 58(3), 58(3)(b), 82(1), 82(2), 117

Crown Suits Act 1947 (WA)

Aliferis v Kyriacou (2000) 179 ALR 477

Allanson v Midland Credit Ltd (1977) 30 FLR 108

Chittick v Maxwell (1993) 118 ALR 728

Coventry v Charter Pacific Corporation Ltd (2005) 227 CLR 234

Kattirtzis v Zaravinos [2001] FCA 1158

Midland Credit Ltd v Official Trustee in Bankruptcy (1982) 68 FLR 53

Re Sharp, Peter Lyle & Ex Parte: Tietyens Investments Pty Ltd (in liq) & Anor v Official Trustee [1998] FCA 1367

IN THE MATTER OF THE BANKRUPT ESTATE OF KEVIN MICHAEL PENKIN

AVON FRANCIS LOVELL v KEVIN MICHAEL PENKIN and OFFICIAL TRUSTEE IN BANKRUPTCY

WAD 31 of 2008

MCKERRACHER J

9 MAY 2008

PERTH

IN THE MATTER OF THE BANKRUPT ESTATE OF KEVIN MICHAEL PENKIN

THE COURT ORDERS THAT:

1.                  To the extent such leave is necessary by reason of the provisions of s 58(3) of the Bankruptcy Act 1966 (Cth), that Avon Francis Lovell have leave to continue and take fresh steps in proceedings instituted by him in the Supreme Court of Western Australia against Kevin Michael Penkin in action CIV 2355 of 2005 (the Action). 

2.                  The granting of leave is conditional upon the applicant, Mr Lovell, undertaking to the Court in writing within 14 days that:

(a)        he will not seek final relief in the Action without having given seven days notice to the office of the Official Trustee;

(b)        he will not oppose any application by the Official Trustee to be joined or heard in the Action.

3.                  Such leave does not extend to the taking of any step to enforce any judgment obtained in the Action without leave first being obtained from this Court. 

4.                  There be no order as to costs, subject to the following order.

5.                  If any party wishes to make submissions which differ from the costs order made in the previous paragraph, written submissions should be filed and served within 14 days. 

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

IN THE MATTER OF THE BANKRUPT ESTATE OF KEVIN MICHAEL PENKIN

REASONS FOR JUDGMENT

Introduction

1                     The applicant, Mr Lovell brought proceedings in 2005 in the Supreme Court of Western Australia against the first respondent, Mr Penkin who had been his solicitor.  The cause of action was in negligence and in contract.  Mr Lovell has now abandoned the contract claim.

2                     After the proceedings in the Supreme Court were issued, Mr Penkin became bankrupt.  On application by the solicitors for the professional indemnity insurer for Mr Penkin, the Supreme Court proceedings were stayed in light of the bankruptcy.  Mr Lovell has therefore brought proceedings in this Court seeking leave to take a fresh step against Mr Penkin in the Supreme Court action.  Alternatively, by an amended motion he seeks in effect, a declaration that no such leave is required on the basis that the cause of action in the Supreme Court proceedings is now a cause of action for unliquidated damages in negligence rather than for breach of retainer. 

3                     For reasons appearing below, I am satisfied that leave should be given.  I have confined the relief to the granting of leave and have imposed conditions.

Statutory Framework

4                     The effect for most purposes of Div 4 of the Bankruptcy Act 1966 (Cth) (the Act) and specifically s 58 is that where a debtor becomes a bankrupt, the property of the bankrupt, not being after-acquired property, vests in the official trustee. 

5                     Subsection 3 accordingly provides as follows:

Except as provided by this Act, after a debtor has become a bankrupt, it is not competent for a creditor:

(a)        to enforce any remedy against the person or the property of the bankrupt in respect of a provable debt; or

(b)       except with the leave of the Court and on such terms as the Court thinks fit, to commence any legal proceeding in respect of a provable debt or take any fresh step in such a proceeding.

6                     Section 82(1) and (2) of the Act provide as follows:

(1)       Subject to this Division, all debts and liabilities, present or future, certain or contingent, to which a bankrupt was subject at the date of the bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy.

…

(2)       Demands in the nature of unliquidated damages arising otherwise than by reason of a contract, promise or breach of trust are not provable in bankruptcy.

7                     Relevantly, s 117 of the Act provides:

117      Policies of insurance against liabilities to third parties

(1)       Where:

(a)        a bankrupt is or was insured under a contract of insurance against liabilities to third parties; and

(b)       a liability against which he or she is or was so insured has been incurred (whether before or after he or she became a bankrupt);

the right of the bankrupt to indemnity under the policy vests in the trustee and any amount received by the trustee from the insurer under the policy in respect of the liability shall, if the liability has not already been satisfied, be paid in full forthwith to the third party to whom it has been incurred.

(2)       Subsection (1) does not limit the rights of the third party in respect of any balance due to him or her after the payment referred to in that subsection has been made.

Background

8                     Mr Lovell is a journalist and author.  Some years ago he engaged Mr Penkin in connection with a prospective claim against the State of Western Australia.  His uncontested evidence is that such claim was not pursued.  He contends that the claim became statute barred or precluded due to the fact that the required notice under the Crown Suits Act 1947 (WA) had not been served by Mr Penkin.  In the Supreme Court proceedings, Mr Lovell contends that Mr Penkin was negligent in failing to serve the Crown Suits Act notice within the relevant time period.  The proceedings against Mr Penkin in the Supreme Court were originally cast in terms of a breach of the implied duty of care contained within the solicitor/client retainer and also in the alternative, for breach of the duty of care owed to Mr Lovell by Mr Penkin. 

9                     Recently, Mr Lovell has amended or sought to amend the pleading with a view to focussing only on the claim in negligence and not on the claim for the breach of retainer.  It is common ground, however, that there was a written retainer executed by Mr Lovell in the form of a costs agreement.  Mr Lovell accepts that a contractual claim is open but says that he has elected to pursue the claim by way of negligence only rather than for breach of contract. 

10                  As all legal practitioners are required to do, Mr Penkin held compulsory professional indemnity insurance in respect of claims such as that brought by Mr Lovell.  The solicitors for the insurer successfully argued in the Supreme Court that the damages sought by Mr Lovell were a provable debt pursuant to s 82(2) of the Act despite being an unliquidated sum and the claim should therefore be stayed pursuant to s 58(3) of the Act.  Reliance was placed on Chittick v Maxwell (1993) 118 ALR 728 in support of the proposition that a claim in tort against a solicitor for professional negligence is a claim that arises out of a contract (that is, a retainer) and accordingly is provable in bankruptcy. 

11                  Mr Lovell argues that as the public interest requires that solicitors should maintain indemnity insurance for the benefit of their clients, that such a statutory requirement in favour of the public should be taken into account in the proper disposition of this matter.  He says that if leave to proceed is necessary it should be granted as, if it is not granted, he will lose his entitlement to proceed with and the benefits from a claim which he contends is straightforward. 

12                  Notwithstanding the stay in the Supreme Court, the Official Trustee in Bankruptcy contends that the claim made by Mr Lovell is not a ‘provable debt’ for the purposes of s 82 of the Act and therefore is not a debt to which s 58(3) of the Act applies.  The Official Trustee also contends that leave is not needed and that it is not appropriate to grant leave without first determining the question of whether the claim by Mr Lovell is provable. 

Granting of Leave

13                  Leave may be granted pursuant to s 58(3)(b) of the Act.  That leave can be granted without determining the merits of the application on the basis that leave is necessary because the issues raised in the application are able to be resolved more thoroughly and expeditiously in proceedings in the Supreme Court of Western Australia. 

14                  It appears to me that this would be an appropriate case for granting leave.  It is unnecessary for present purposes to go into detail as to the nature of the claim in the Supreme Court but suffice it to say that negligence actions against legal practitioners in the State of Western Australia especially pertaining to failure to serve a particular form of notice under a State Act would more customarily be heard in that court.  Allowing matters to take their usual course would be more efficient than the alternative procedure of requiring Mr Lovell to lodge a proof of debt in respect of his claim against Mr Penkin and then having to appeal from a decision of the trustee, if any, to reject that claim.  Such an appeal would require determination of issues in a ‘less satisfactory way than the Supreme Court proceeding and it is possible that questions between Mr Penkin and Mr Lovell would not be resolved’.  In Allanson v Midland Credit Ltd (1977) 30 FLR 108 per Bowen CJ, Riley and Deane JJ it was said at 114:

Before proceeding further with the question of the effect of the stay and the operation of s 58(3), it is convenient to consider the second question which arises.  That is, whether the court, if it has jurisdiction, should grant leave in the present case.  Franki J, while indicating that as then advised he would not have answered this question in the affirmative, never reached the stage where it was necessary to decide it.  The facts are complex.  The claim of Midland Credit is not only against Mr Allanson, but against other defendants who, in some respects, may be jointly and severally liable with him.  There is also the question of the defences, some of which form the basis of the cross-claim.  It would seem that all of these issues would be better and more comprehensively dealt with by a contested trial of the action in the Supreme Court than could possibly be the case if Midland credit were required to lodge a proof of debt in respect of its claim against Mr Allanson alone.  Such a proof of debt would be in the form of an affidavit and determined by the official receiver at such time as the stay ceased to operate.  If the official receiver disallowed the claim in whole or in part, an appeal on this isolated issue could be brought to the Bankruptcy Court.  But in these circumstances, the issues would have been determined in a less satisfactory way and questions between Mr Allanson and the other parties to the action would not be resolved.

It is not suggested that if leave be granted, the bankrupt estate will suffer financially in any way.

In the circumstances, we have formed the view that, if s 58(3) applies, the court has jurisdiction to grant leave to proceed and such leave should be granted.

15                  The Supreme Court proceedings have been on foot for some time (albeit that a defence has not yet been filed).  As to this, see the analysis in Allanson 30 FLR 108 and in Midland Credit Ltd v Official Trustee in Bankruptcy (1982) 68 FLR 53.  While that consideration may be of greater significance in circumstances where a substantial amount of time, effort and cost has been allocated to bringing the proceedings close to trial and the facts are complex, it appears to me that the facts in this case are sufficiently complex having regard to an extensive history of other litigation with which Mr Lovell has been involved in the Supreme Court and the complexities surrounding the law concerning service of a notice under the Crown Suits Act.  Then again, there are the highly complex facts and law concerning Mr Lovell’s likely prospects of having succeeded in a claim against the State of Western Australia, had it been brought.  These are all issues best dealt with by the Supreme Court where this action and others concerning Mr Lovell, have been running. 

Is Leave Required?

16                  I turn then to consider whether leave is actually required.  There could be little doubt in a claim such as this, that the damages in respect of which the claim is pursued are very much unliquidated.  There is a debate about whether an unliquidated damages claim that can arise both in contract and in tort is a provable debt or whether it comes under the exception in s 82(2) of the Act. 

17                  In relation to claims against solicitors, one argument is that it is proper to characterise such claims as arising ‘by reason of’ contract, namely, of the express or implied retainer.  As such, the claim would be provable despite being for unliquidated damages.  This is on the basis that the claim would not have arisen but for the contract of retainer between the professional and the client.  In the present circumstances there is a costs agreement constituting the retainer so that clearly the relationship was established at least in part by virtue of the contractual retainer.  This approach stems from cases such as Chittick 118 ALR 728 at 736 and 739; and Re Sharp, Peter Lyle & Ex Parte: Tietyens Investments Pty Ltd (in liq) & Anor v Official Trustee [1998] FCA 1367. 

18                  In Chittick 118 ALR 728 at 738-739 Young J said:

Dr Bennett QC submits that the causes of action in negligence and breach of fiduciary duty resulting in equitable compensation are released because they fall within the words “by reason of a contract, promise or breach of trust” in s 82(2). He puts that in considering whether the claim is one for unliquidated damages arising by reason of a contract, promise or breach of trust one looks to the underlying transaction rather than to the form of action. He puts that the claim in negligence in this case clearly arises out of a contract or promise in the relevant sense. There was a promise even though made without consideration by Mr Maxwell that he would protect the plaintiffs by the use of appropriate legal skill. Counsel claims that the claim for equitable compensation rises out of a contract or out of a promise or out of a breach of trust. He puts that the words “arose out of” in s 82(2) should be widely construed.

Mr Hely QC, on the other hand, puts that s 82 is not concerned with making unliquidated damages for a personal fault provable in the bankruptcy. He points out that s 82 does not talk about breach of fiduciary duty, and that there is a very real distinction between a breach of trust and a breach of fiduciary duty; in particular the solicitor who commits a breach of fiduciary duty does not have property vested in him. Again, equitable compensation can under no stretch of the imagination be classed as unliquidated damages but, even if it could be so classed, then the claim did not arise by reason of contract, promise or breach of trust.

Dr Bennett QC commenced with the words of James LJ in Ex parte Llynvi Coal & Iron Co; Re Hide (1871) LR 7 Ch App 28 at 31–2, where his Lordship said on the Bankruptcy Act 1869 (Imp):

A great number of cases occurred, before the passing of the late Act, in which the bankrupt was left liable to several claims of various kinds, and the persons who had those claims were entirely excluded from any participation in the general division of the assets. Then came the Act of parliament, which — dealing in express terms with almost every one of the cases which had ever previously occurred, and excluding nothing but demands for damages for personal torts — provided that there should be nothing whatever for which a right of proof should not be given. Every possible demand, every possible claim, every possible liability, except for personal torts, is to be the subject of proof in bankruptcy … The broad purview of this Act is that the bankrupt is to be a freed man — freed not only from debts, but from contracts, liabilities, engagements and contingencies of every kind.

Dr Bennett QC then relies on Britter v Sprigg (1900) 26 VLR 65 at 82, where the Victorian Full Court dealt with the Insolvency Act 1890 (Vic). In that case the Full Court held that the wrongful receipt by a director of a building society of moneys of the society by way of commission constituted a debt provable in insolvency. At 82 Madden CJ said:

We think, upon interpretation of s 114 of the Insolvency Act 1890, that this obligation is one provable in insolvency. We think that upon the verbiage of the statute the section is one which, though confused and indefinite, is exceedingly comprehensive, and that this obligation is a debt provable in insolvency. This opinion is confirmed by the case of Emma Silver Mining Co v Grant (1880) 17 Ch D 122, wherein it is declared that the obligation of a director who is in a fiduciary position may be considered that of a contractor, so that he must observe the principles of his trust and not contravene them, and that a breach of his obligation not to make such a payment as this would be a breach of trust. We think the relationship of a director to his company is on this principle contractual. It is therefore within s 114.

I should note that s 114 of the Victorian 1890 Act provided that: “Demands in the nature of unliquidated damages arising otherwise than by reason of a contract or promise shall not be provable in insolvency.” However, the Emma Silver Mining Co case is also authority for the proposition that a secret commission is a fraud from which a bankrupt is not released under s 153(2)(b).

At least if there is a breach of trust in the strict sense, these principles have never been departed from: see, for more recent examples, Cutten and Harvey v Mount (1988) 14 ACLR 662 at 667 and Re Vassis; Ex parte Leung (1986) 9 FCR 518 at 527.

McPherson on Company Liquidation, 3rd ed, p 375, truly says:

The tendency is to give a narrow interpretation to the exclusionary aspect of s 82(2) and the following claims have been held to fall outside its scope: claims in respect of secret profits for breach of fiduciary duty, for profits made by infringing a patent, for damages in respect of misrepresentation inducing a contract, or rectification of the share register, and for contribution against a joint tortfeasor. In addition there is a general principle that a person with alternative remedies in contract and tort may elect to waive the tort and prove in contract …

McPherson then refers (p 380) to Re Southern Cross Coaches Ltd (1932) 49 WN(NSW) 230, where in a bus collision passengers in the bus of the company being wound up were able to prove because their claim arose out of a contract made with the bus company to carry them safely, whereas claims by passengers in the other bus were excluded from proof because they lay purely as a matter of personal tort. (emphasis added)

The width of the section is further illustrated by the cases discussed by the High Court in Gye v McIntyre (1991) 98 ALR 393 ; 171 CLR 609 at 632 and following. It seems to me that Dr Bennett QC's submissions on this point have to be accepted. The case in tortious negligence is one that arises out of a contract or promise in the sense that it was failure to fulfil the promise to protect. It does not seem to me that it matters that there was no cause of action in contract because there was no promise for consideration. It is sufficient that there is a claim at law or in equity and that that claim is for damages which arises out of a contract or promise. Likewise, the cases to which I have referred show that it does not matter that the claim should properly be classified as equitable compensation.

19                  However, the approach taken subsequently by the Victorian Court of Appeal was that regardless of the contract of retainer between a solicitor and a client, a claim in negligence could still be characterised as an unliquidated claim for damages in negligence because the contract was not an essential element of the claim.  Charles JA observed in Aliferis v Kyriacou (2000) 179 ALR 477 at [46]-[51]:

[46]     Notwithstanding this endorsement of the decision in Chittick, in so far as the judgment suggests that the present claim is one for a provable debt and accordingly not excluded from the general release provided by s 82(1), I would, with great respect, not follow it. It seems to me rather that the correct test to apply for the purpose of deciding whether a demand is within the exclusion provided by s 82(2), leaving breach of trust to one side, is whether a contract or promise constitutes an essential element of the cause of action. In a claim for unliquidated damages for professional negligence against a solicitor, the pleading of the retainer will often, if not usually, be necessary, but only for the purposes of delineating and defining the scope of the professional's duty of care. For reasons such as those given by Lord Wright in Grant's case the pleading of the contract or retainer, however, is not an essential element in the cause of action.

[47]     Mr Stuckey also relied on Emma Silver Mining Co v Grant; Jack v Kipping and Britter v Sprigg in support of his submissions that the language of s 82(2) is not directed at causes of action, but rather at the cause or basis of the demand and that the proper approach is to examine whether the demand arises by reason of a contract, even though the cause of action giving rise to liability is not for breach of contract.

[48]     In each of these cases the claim was regarded as provable, but, in my view, each is distinguishable. In Emma Silver Mining the claim was “in the nature of an ordinary debt due by an agent in respect of money had and received by way of secret profit” and was so treated by Sir George Jessel. The claim was not for unliquidated damages and was regarded as arising under a contract. Jack v Kipping was a claim for unliquidated damages for a fraudulent misrepresentation which induced the claimant to contract to purchase shares. Cave J, speaking for himself and Mathew J said that:

It is said that such a fraudulent misrepresentation is a tort; but we think that it is not a personal tort, but a breach of the obligation arising out of the contract of sale.

This decision was doubted by McLelland CJ in Eq in Re NIAA Corp Ltd (in liq) where his Honour said of the passage just quoted:

Whether this assimilation was justifiable for the purpose of the “mutual dealings” provision, the application of which is limited to provable claims, is questionable, particularly as no attention was paid in that case to the decision in Ex parte Baum. However, the real thrust of the decision seems to have been that to deny a set-off in the circumstances of that case “would be inequitable”, which suggests that the decision should properly be treated as illustrating the availability in those circumstances of an equitable set-off, making reliance on the “mutual dealings” provision and the question of whether the claim was provable in the bankruptcy, otiose.

Plainly there were other considerations bearing upon the decision in Jack v Kipping. In Britter v Sprigg it was held, following Emma Silver Mining, that the wrongful receipt by the director of a building society of moneys of the society by way of commission, being both a breach of trust and contractual, constituted a debt provable in insolvency within the meaning of s 114 of the Insolvency Act 1890.

[49]     I should add that in In the Estate of Fitzhardinge (dec'd); Ex parte Hely, Manning J held that a right of action against a bankrupt solicitor for not duly prosecuting an action for his client was in substance for negligence, and damages for such negligence were not capable of proof under s 45(1) of the Bankruptcy Act 1887 (NSW).

[50]     In the judgment now under appeal, the learned judge preferred the decision of Young J in Chittick to that of Manning J in Fitzhardinge. His Honour said that the exception in s 82(2) should be read very narrowly, relying on Ex parte Llynvi Coal and Iron Co and continued:

The duty relied upon by the plaintiff in the present case only arose by reason of the existence of the contract between the plaintiff, her husband and the defendant. That is clear from the pleadings. The duty and the terms of the retainer are the same. It is clear, therefore, that the plaintiff's claim is a demand which arises by reason of a contract.

[51]     The statement of claim did indeed include an allegation that the plaintiff and her husband retained the defendant, as well as pleading some of the terms of the retainer. But I do not accept that the plaintiff's claim in negligence is therefore a demand which arises by reason of a contract. In my view the contract does not constitute an essential element in the plaintiff's cause of action in negligence, and her tortious claim is “a demand in the nature of unliquidated damages arising otherwise than by reason of a contract promise or breach of trust” within the meaning of s 82(2) of the Bankruptcy Act. It was therefore not provable in the defendant's bankruptcy and the plaintiff was not required to obtain leave from the Federal Court of Australia before pursuing it. (footnotes omitted)

20                  The High Court came to consider Aliferis 179 ALR 477 in Coventry v Charter Pacific Corporation Ltd (2005) 227 CLR 234.  The opening paragraphs of that decision indicate the consequences of the correct characterisation:

4          If the claim for unliquidated damages made pursuant to the Corporations Law is a debt provable in that person's bankruptcy, discharge from bankruptcy operates to release that person from that claim.  If it is not a debt provable in the bankruptcy, discharge from bankruptcy does not operate to release the bankrupt from the claim and, subject to any question of limitation of actions, the claim can be pursued against the former bankrupt after discharge.  Moreover, s 58(3) of the Bankruptcy Act 1966 (Cth) does not prevent the claimant, during the bankruptcy, from commencing a legal proceeding in respect of the claim or enforcing any remedy against the person or the property of the bankrupt in respect of that claim.  The sub section denies such competency to a creditor only in respect of "a provable debt".

5          The central question in the appeal hinges on the meaning of s 82(2) of the Bankruptcy Act 1966 and, in particular, what is meant by a demand in the nature of unliquidated damages arising otherwise than by reason of a contract or promise.  That expression, used to identify an exception to the definition of debts provable in bankruptcy, has been held not to include a claim for unliquidated damages for fraudulent misrepresentation which induced the party misled to make a contract with the bankrupt (a "bilateral" case).  That is, such a claim for damages has been held to be a debt provable in the bankruptcy, and a claim that was to be set off against a claim by the bankrupt estate.  But a claim for unliquidated damages for fraudulent misrepresentations where the representations induced the claimant to make a contract with another (a "tripartite" case) has been held not to be a claim provable in the bankruptcy.  The bankrupt having made no contract with the party who claims damages from the bankrupt, the claim for damages for fraudulent misrepresentation has been held to be a demand arising otherwise than by reason of a contract or promise.

6          These reasons demonstrate that a statutory claim for unliquidated damages for misleading or deceptive conduct which induced the claimant to make a contract not with the bankrupt but with a third party is not a debt provable in bankruptcy.  It is a demand in the nature of unliquidated damages arising otherwise than by reason of a contract or promise.  The bankrupt is not discharged from liability.  The claim may be pursued by the claimant during the bankruptcy and after discharge from bankruptcy.  By contrast, a claim for unliquidated damages for misleading or deceptive conduct by the bankrupt, which induced the claimant to make a contract with the bankrupt, would be a debt provable in bankruptcy. (footnotes omitted)

21                  To move forward in the judgment to the topic most relevant to the current issue (at [64]), the High Court rejected the principle reasoning expressed by the Court of Appeal in Victoria in Aliferis 179 ALR 477 which in turn had been followed in a number of subsequent cases:

[64]     Aliferis was a bilateral case. It concerned a claim, pleaded in both contract and tort, by a client against a solicitor alleging negligent performance of a retainer. The solicitor entered a deed of arrangement under Pt X of the Bankruptcy Act but the client (the plaintiff in the action) did not participate in the arrangement. Was the client’s claim a debt provable in bankruptcy?

[65]     The Court of Appeal of Victoria held that the claim was one arising otherwise than by reason of a contract and thus not a claim provable in the solicitor’s bankruptcy. The court held that a claim arises by reason of a contract or promise only if a contract or promise is an “element” or “essential element” of the cause of action. Charles JA, with whose reasons the other members of the court agreed, held that the pleading of the contract of retainer was not an essential element of the cause of action in negligence.

[66]     Two points must be made about this conclusion and the reasoning underpinning it. First, the decision appears to proceed from an assumption that, despite the way the case was pleaded, the claim actually pursued was framed only as a claim in tort. It is not necessary to examine whether, in the particular circumstances of that case, the assumption was well founded. Even if the assumption was well founded, Jack v Kipping reveals that framing a claim as a claim in tort does not conclude the question whether the demand arises by reason of a contract or promise.

[67]     The second and more important point is that the test stated in Aliferis, and applied by the Court of Appeal in the present matter, to decide whether a demand arises by reason of a contract or promise does not satisfactorily reflect the meaning to be given to s 82(2). It should not be adopted or applied.

[68]     The test stated in Aliferis does not give any weight to the need to read s 82(2) in the light provided by the set-off provisions of s 86. It is a test which does not distinguish between bilateral and tripartite cases. It treats as the critical question whether the claimant must plead the existence of a contract, any contract. It treats as irrelevant whether the bankrupt was a party to the contract.

[69]     Further, to express the relevant test in the way it was in Aliferis places heavy emphasis upon the way in which the particular claim is or could be pleaded. That may serve only to mask what is to be understood by the reference to “element” or “essential element”. Thus, in the present case, this formulation of the test provoked debate about whether the manner in which Charter Pacific alleged that it had suffered damage (by performance of contractually stipulated obligations) was an “essential element” of the claim for damages for misleading or deceptive conduct. Approaching the problem in that way shifts attention away from the statutory test to subsidiary questions about proper pleading practice.

[70]     What is revealed by the analysis of decided cases recorded in the preceding pages of these reasons is that s 82(2) and its legislative predecessors stopped short of providing that “the bankrupt is to be a freed man — freed not only from debts, but from contracts, liabilities, engagements, and contingencies of every kind” (emphasis added). Some claims stand outside the reach of the statute. Although consideration of the application of the set-off provision required the inclusion, within the class of debts provable in bankruptcy, of those claims for unliquidated damages for fraudulent misrepresentation which had induced the making of a contract between the bankrupt and the claimant, the words of the section were not and are not to be stretched to encompass every other kind of claim which a person may have against the bankrupt.

22                  Prior to dealing with Aliferis 179 ALR 477, in its analysis in Coventry227 CLR 234, the High Court also supported its reasoning by reference to the set-off provisions in the Act.  Again the historical analysis was detailed but the following extract is in point:

Set-off in bankruptcy

30        The history of the balancing accounts in bankruptcy and the development of the rights of set off in bankruptcy, together with the competing theories respecting their origins, were considered by Powell JA in Gye v Davies.  For a very long time, the right of set off in bankruptcy has not rested on the same principles as the right of set off between solvent parties.  The latter right was given by the Statutes of Set off of 1729 and 1735 (2 Geo II c 22 s 13 and 8 Geo II c 24 s 4) to prevent cross action.  Separate provision was made for set off in bankruptcy, first in 1705 (4 & 5 Ann c 17), continued in 1732 (5 Geo II c 30), and re enacted in 1825 (6 Geo IV c 16).

31        In Forster v Wilson, Parke B remarked that the right of set off given by the Georgian statutes of set off was to prevent cross actions between solvent parties in respect of legal debts due to each in his own right.  His Lordship contrasted the statutory set off in bankruptcy as given "not to avoid cross actions, for none would lie against assignees [in bankruptcy], and one against the bankrupt would be unavailing, but to do substantial justice between the parties, where a debt is really due from the bankrupt to the debtor to his estate".  The 1825 statute (6 Geo IV c 16) was a consolidating statute which replaced the various statutes which until then had set out the law of bankruptcy.  Section 50 was confined to mutual credits and mutual debts but went on to say that "every Debt or Demand hereby made proveable against the Estate of the Bankrupt, may also be set off in manner aforesaid".  A provision to like effect appeared as s 171 of the Bankruptcy Law Consolidation Act 1849.

32        Writing of the decisions given in this period, Derham states:

Sometimes, when the courts held that a particular claim could not be employed in a set off pursuant to the 1825 or the 1849 set off section, the justification was that the demand was not provable, although this was not always the case.  There are instances in which the courts instead had regard to the definition of mutual credit adopted in Rose v Hart as a means of rejecting an argument for a set off.

This emphasis upon the requirement of mutuality is to be seen in the later nineteenth century cases to which further reference will be made later in these reasons.

33        In the 1869 English Act the reach of the set off provision was extended to "other mutual dealings".  Section 39 provided that:

Where there have been mutual credits, mutual debts, or other mutual dealings between the bankrupt and any other person proving or claiming to prove a debt under his bankruptcy, an account shall be taken of what is due from the one party to the other in respect of such mutual dealings, and the sum due from the one party shall be set off against any sum due from the other party, and the balance of such account, and no more, shall be claimed or paid on either side respectively; but a person shall not be entitled under this section to claim the benefit of any set off against the property of a bankrupt in any case where he had at the time of giving credit to the bankrupt notice of an act of bankruptcy committed by such bankrupt and available against him for adjudication.

Again, the provision made in s 86 of the Bankruptcy Act 1966 for set off is evidently based on the model of the 1869 English Act.  Section 86 (again in the form in which it stood when Charter Pacific commenced its action) provided:

(1)        Subject to this section, where there have been mutual credits, mutual debts or other mutual dealings between a person who has become a bankrupt and a person claiming to prove a debt in the bankruptcy:

(a)        an account shall be taken of what is due from the one party to the other in respect of those mutual dealings;

(b)        the sum due from the one party shall be set off against any sum due from the other party; and

(c)        only the balance of the account may be claimed in the bankruptcy, or is payable to the trustee in the bankruptcy, as the case may be.

(2)        A person is not entitled under this section to claim the benefit of a set off if, at the time of giving credit to the person who has become a bankrupt or at the time of receiving credit from that person, he had notice of an available act of bankruptcy committed by that person.

34        For present purposes, what is important to notice is that the set off provisions found in both Acts are engaged where there have been mutual dealings between the bankrupt and another person proving or claiming to prove a debt in the bankruptcy.  The set off cases therefore cast light upon what debts are provable in bankruptcy.  And what an examination of the nineteenth century cases will reveal is that the set off provisions were used to extend the reach of debts provable in bankruptcy by giving to the expression "demand in the nature of unliquidated damages arising … by reason of a contract or promise" a more ample operation than the words might at first have been thought to suggest.

…

50        Why should this understanding of s 31 of the 1869 English Act be carried over to the construction of s 82(2) of the Bankruptcy Act 1966?  Again, there are two related reasons.  First, the text of s 82, like its legislative ancestors, shows that not all claims are provable in bankruptcy.  Some content must therefore be given to s 82(2) and its reference to demands "arising otherwise than by reason of a contract, promise or breach of trust".  Secondly, any amplification or extension of the content to be given to s 82(2), beyond the immediate operation conveyed by reference to demands arising by reason of a contract or promise, is to be fixed by reference to the operation of other provisions of the statute, and particularly the set off provisions of s 86.  A claim which may be made in answer to a claim which the bankrupt estate makes for damages for breach of a contract between bankrupt and claimant may be provable.  That answering claim may be provable because it arises out of the mutual dealing or bilateral relationship of contract between bankrupt and claimant.  By contrast, a claim which comes from a tripartite transaction, in which the bankrupt's misrepresentation induced the claimant to make a contract with a third party, does not arise from a mutual dealing and it arises otherwise than by reason of a contract or promise.

51        It is against the background provided by these nineteenth century English cases that the Australian cases must be considered.  Not only is the drafting of the relevant provisions of the Bankruptcy Act 1966 for all practical purposes identical to the statutory language considered in those cases, there is the same need to work out the relationship between the provision for what debts are provable in bankruptcy (s 82) and the provision for set off (s 86).  (footnotes omitted)

23                  The present circumstance may be governed by the view of the majority of the High Court in Coventry 227 CLR 234 to the effect that ‘Jack v Kipping (1882) 9 Qbd 113 reveals that framing a claim as a claim in tort does not conclude the question whether a claim arises by reason of a contract or promise’:  see Coventry at [66]. 

24                  From this, does it follow in the present circumstances that Chittick 118 ALR 728 and Re Sharp [1998] FCA 1367 are to be taken as establishing that although Mr Lovell pursues his claim in tort, it is nevertheless a claim which arises by reason of the contract (the retainer) or even a promise (express or implied)?  The High Court in Coventry227 CLR 234 rejected the process of reasoning which examines whether or not reliance on a claim in contract is an essential element of the claim.  Does it follow that the law reverts to that as stated in Chittick 118 ALR 728, namely, that although the claim is pleaded in tort, it is also a claim rising by reason of the contract of retainer?  If so, then it would a provable debt and leave would be required under s 58(3)(b) of the Act.

25                  In short, I take Coventry227 CLR 234 to emphasise that the historical development of the Act and its predecessors is such that the class of claims that are provable will be very wide and conversely, the exceptions under s 82(2) of the Act cover a class of claims that is narrow.  While Coventrywas not dealing with a claim like the present which is in negligence alone against a solicitor, the rationale developed in the decision would appear to me to support a conclusion that such a claim is provable. 

26                  The Official Trustee’s submission to the effect that a claim in tort would not be provable carries some weight.  But this is a claim which has a contractual nexus by virtue of the retainer.  It also involves mutuality of dealings and a set-off (by virtue of the contest between Mr Lovell and Mr Penkin having originated in Mr Penkin suing for outstanding unpaid fees) and finally, arises from a one-on-one or bilateral rather than tripartite relationship.  All those elements, in light of the High Court’s rejection of the ‘essential element’ test, would cause me to have doubts as to the submission by the Official Trustee that no leave is required. 

Section 117 of the Act

27                  It is common ground between the parties to this proceeding that it is a requirement to obtain a practicing certificate in all jurisdictions and that the practitioner hold appropriate insurance against liabilities incurred in practice. 

28                  Section 117 of the Act now provides that where a bankrupt has incurred a liability against which he or she was insured, the right of indemnity vests in the trustee and the amount received from the insurer should be paid forthwith to the party to whom the liability has been incurred.  The Official Trustee contends that this is not a proper basis on which to determine the issues arising in this application as there is nothing before the Court about the extent of the insurance held by Mr Penkin.  Indeed, it is argued that there is nothing to say that the insurer has agreed to indemnify Mr Penkin on the basis of the terms in the policy of insurance.  In that case, the burden would fall on the bankrupt estate to meet the claim by Mr Lovell against Mr Penkin.  Secondly, the Official Trustee contends that if a claim for negligence against a legal practitioner were found to be provable in all cases, it is conceivable that an insurer may review its position in relation to bankrupt practitioners, knowing that a claim of negligence may be met from the proceeds of the practitioner’s estate and/or discharged by the bankruptcy. 

29                  Both of these outcomes, it is submitted, would be contrary to a broader consideration of public policy if the practical benefit of the claim of neMCKERRACHER J

9 MAY 2008

PERTH

IN THE MATTER OF THE BANKRUPT ESTATE OF KEVIN MICHAEL PENKIN

THE COURT ORDERS THAT:

1.                  To the extent such leave is necessary by reason of the provisions of s 58(3) of the Bankruptcy Act 1966 (Cth), that Avon Francis Lovell have leave to continue and take fresh steps in proceedings instituted by him in the Supreme Court of Western Australia against Kevin Michael Penkin in action CIV 2355 of 2005 (the Action). 

2.                  The granting of leave is conditional upon the applicant, Mr Lovell, undertaking to the Court in writing within 14 days that:

(a)        he will not seek final relief in the Action without having given seven days notice to the office of the Official Trustee;

(b)        he will not oppose any application by the Official Trustee to be joined or heard in the Action.

3.                  Such leave does not extend to the taking of any step to enforce any judgment obtained in the Action without leave first being obtained from this Court. 

4.                  There be no order as to costs, subject to the following order.

5.                  If any party wishes to make submissions which differ from the costs order made in the previous paragraph, written submissions should be filed and served within 14 days. 

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

IN THE MATTER OF THE BANKRUPT ESTATE OF KEVIN MICHAEL PENKIN

REASONS FOR JUDGMENT

Introduction

1                     The applicant, Mr Lovell brought proceedings in 2005 in the Supreme Court of Western Australia against the first respondent, Mr Penkin who had been his solicitor.  The cause of action was in negligence and in contract.  Mr Lovell has now abandoned the contract claim.

2                     After the proceedings in the Supreme Court were issued, Mr Penkin became bankrupt.  On application by the solicitors for the professional indemnity insurer for Mr Penkin, the Supreme Court proceedings were stayed in light of the bankruptcy.  Mr Lovell has therefore brought proceedings in this Court seeking leave to take a fresh step against Mr Penkin in the Supreme Court action.  Alternatively, by an amended motion he seeks in effect, a declaration that no such leave is required on the basis that the cause of action in the Supreme Court proceedings is now a cause of action for unliquidated damages in negligence rather than for breach of retainer. 

3                     For reasons appearing below, I am satisfied that leave should be given.  I have confined the relief to the granting of leave and have imposed conditions.

Statutory Framework

4                     The effect for most purposes of Div 4 of the Bankruptcy Act 1966 (Cth) (the Act) and specifically s 58 is that where a debtor becomes a bankrupt, the property of the bankrupt, not being after-acquired property, vests in the official trustee. 

5                     Subsection 3 accordingly provides as follows:

Except as provided by this Act, after a debtor has become a bankrupt, it is not competent for a creditor:

(a)        to enforce any remedy against the person or the property of the bankrupt in respect of a provable debt; or

(b)       except with the leave of the Court and on such terms as the Court thinks fit, to commence any legal proceeding in respect of a provable debt or take any fresh step in such a proceeding.

6                     Section 82(1) and (2) of the Act provide as follows:

(1)       Subject to this Division, all debts and liabilities, present or future, certain or contingent, to which a bankrupt was subject at the date of the bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy.

…

(2)       Demands in the nature of unliquidated damages arising otherwise than by reason of a contract, promise or breach of trust are not provable in bankruptcy.

7                     Relevantly, s 117 of the Act provides:

117      Policies of insurance against liabilities to third parties

(1)       Where:

(a)        a bankrupt is or was insured under a contract of insurance against liabilities to third parties; and

(b)       a liability against which he or she is or was so insured has been incurred (whether before or after he or she became a bankrupt);

the right of the bankrupt to indemnity under the policy vests in the trustee and any amount received by the trustee from the insurer under the policy in respect of the liability shall, if the liability has not already been satisfied, be paid in full forthwith to the third party to whom it has been incurred.

(2)       Subsection (1) does not limit the rights of the third party in respect of any balance due to him or her after the payment referred to in that subsection has been made.

Background

8                     Mr Lovell is a journalist and author.  Some years ago he engaged Mr Penkin in connection with a prospective claim against the State of Western Australia.  His uncontested evidence is that such claim was not pursued.  He contends that the claim became statute barred or precluded due to the fact that the required notice under the Crown Suits Act 1947 (WA) had not been served by Mr Penkin.  In the Supreme Court proceedings, Mr Lovell contends that Mr Penkin was negligent in failing to serve the Crown Suits Act notice within the relevant time period.  The proceedings against Mr Penkin in the Supreme Court were originally cast in terms of a breach of the implied duty of care contained within the solicitor/client retainer and also in the alternative, for breach of the duty of care owed to Mr Lovell by Mr Penkin. 

9                     Recently, Mr Lovell has amended or sought to amend the pleading with a view to focussing only on the claim in negligence and not on the claim for the breach of retainer.  It is common ground, however, that there was a written retainer executed by Mr Lovell in the form of a costs agreement.  Mr Lovell accepts that a contractual claim is open but says that he has elected to pursue the claim by way of negligence only rather than for breach of contract. 

10                  As all legal practitioners are required to do, Mr Penkin held compulsory professional indemnity insurance in respect of claims such as that brought by Mr Lovell.  The solicitors for the insurer successfully argued in the Supreme Court that the damages sought by Mr Lovell were a provable debt pursuant to s 82(2) of the Act despite being an unliquidated sum and the claim should therefore be stayed pursuant to s 58(3) of the Act.  Reliance was placed on Chittick v Maxwell (1993) 118 ALR 728 in support of the proposition that a claim in tort against a solicitor for professional negligence is a claim that arises out of a contract (that is, a retainer) and accordingly is provable in bankruptcy. 

11                  Mr Lovell argues that as the public interest requires that solicitors should maintain indemnity insurance for the benefit of their clients, that such a statutory requirement in favour of the public should be taken into account in the proper disposition of this matter.  He says that if leave to proceed is necessary it should be granted as, if it is not granted, he will lose his entitlement to proceed with and the benefits from a claim which he contends is straightforward. 

12                  Notwithstanding the stay in the Supreme Court, the Official Trustee in Bankruptcy contends that the claim made by Mr Lovell is not a ‘provable debt’ for the purposes of s 82 of the Act and therefore is not a debt to which s 58(3) of the Act applies.  The Official Trustee also contends that leave is not needed and that it is not appropriate to grant leave without first determining the question of whether the claim by Mr Lovell is provable. 

Granting of Leave

13                  Leave may be granted pursuant to s 58(3)(b) of the Act.  That leave can be granted without determining the merits of the application on the basis that leave is necessary because the issues raised in the application are able to be resolved more thoroughly and expeditiously in proceedings in the Supreme Court of Western Australia. 

14                  It appears to me that this would be an appropriate case for granting leave.  It is unnecessary for present purposes to go into detail as to the nature of the claim in the Supreme Court but suffice it to say that negligence actions against legal practitioners in the State of Western Australia especially pertaining to failure to serve a particular form of notice under a State Act would more customarily be heard in that court.  Allowing matters to take their usual course would be more efficient than the alternative procedure of requiring Mr Lovell to lodge a proof of debt in respect of his claim against Mr Penkin and then having to appeal from a decision of the trustee, if any, to reject that claim.  Such an appeal would require determination of issues in a ‘less satisfactory way than the Supreme Court proceeding and it is possible that questions between Mr Penkin and Mr Lovell would not be resolved’.  In Allanson v Midland Credit Ltd (1977) 30 FLR 108 per Bowen CJ, Riley and Deane JJ it was said at 114:

Before proceeding further with the question of the effect of the stay and the operation of s 58(3), it is convenient to consider the second question which arises.  That is, whether the court, if it has jurisdiction, should grant leave in the present case.  Franki J, while indicating that as then advised he would not have answered this question in the affirmative, never reached the stage where it was necessary to decide it.  The facts are complex.  The claim of Midland Credit is not only against Mr Allanson, but against other defendants who, in some respects, may be jointly and severally liable with him.  There is also the question of the defences, some of which form the basis of the cross-claim.  It would seem that all of these issues would be better and more comprehensively dealt with by a contested trial of the action in the Supreme Court than could possibly be the case if Midland credit were required to lodge a proof of debt in respect of its claim against Mr Allanson alone.  Such a proof of debt would be in the form of an affidavit and determined by the official receiver at such time as the stay ceased to operate.  If the official receiver disallowed the claim in whole or in part, an appeal on this isolated issue could be brought to the Bankruptcy Court.  But in these circumstances, the issues would have been determined in a less satisfactory way and questions between Mr Allanson and the other parties to the action would not be resolved.

It is not suggested that if leave be granted, the bankrupt estate will suffer financially in any way.

In the circumstances, we have formed the view that, if s 58(3) applies, the court has jurisdiction to grant leave to proceed and such leave should be granted.

15                  The Supreme Court proceedings have been on foot for some time (albeit that a defence has not yet been filed).  As to this, see the analysis in Allanson 30 FLR 108 and in Midland Credit Ltd v Official Trustee in Bankruptcy (1982) 68 FLR 53.  While that consideration may be of greater significance in circumstances where a substantial amount of time, effort and cost has been allocated to bringing the proceedings close to trial and the facts are complex, it appears to me that the facts in this case are sufficiently complex having regard to an extensive history of other litigation with which Mr Lovell has been involved in the Supreme Court and the complexities surrounding the law concerning service of a notice under the Crown Suits Act.  Then again, there are the highly complex facts and law concerning Mr Lovell’s likely prospects of having succeeded in a claim against the State of Western Australia, had it been brought.  These are all issues best dealt with by the Supreme Court where this action and others concerning Mr Lovell, have been running. 

Is Leave Required?

16                  I turn then to consider whether leave is actually required.  There could be little doubt in a claim such as this, that the damages in respect of which the claim is pursued are very much unliquidated.  There is a debate about whether an unliquidated damages claim that can arise both in contract and in tort is a provable debt or whether it comes under the exception in s 82(2) of the Act. 

17                  In relation to claims against solicitors, one argument is that it is proper to characterise such claims as arising ‘by reason of’ contract, namely, of the express or implied retainer.  As such, the claim would be provable despite being for unliquidated damages.  This is on the basis that the claim would not have arisen but for the contract of retainer between the professional and the client.  In the present circumstances there is a costs agreement constituting the retainer so that clearly the relationship was established at least in part by virtue of the contractual retainer.  This approach stems from cases such as Chittick 118 ALR 728 at 736 and 739; and Re Sharp, Peter Lyle & Ex Parte: Tietyens Investments Pty Ltd (in liq) & Anor v Official Trustee [1998] FCA 1367. 

18                  In Chittick 118 ALR 728 at 738-739 Young J said:

Dr Bennett QC submits that the causes of action in negligence and breach of fiduciary duty resulting in equitable compensation are released because they fall within the words “by reason of a contract, promise or breach of trust” in s 82(2). He puts that in considering whether the claim is one for unliquidated damages arising by reason of a contract, promise or breach of trust one looks to the underlying transaction rather than to the form of action. He puts that the claim in negligence in this case clearly arises out of a contract or promise in the relevant sense. There was a promise even though made without consideration by Mr Maxwell that he would protect the plaintiffs by the use of appropriate legal skill. Counsel claims that the claim for equitable compensation rises out of a contract or out of a promise or out of a breach of trust. He puts that the words “arose out of” in s 82(2) should be widely construed.

Mr Hely QC, on the other hand, puts that s 82 is not concerned with making unliquidated damages for a personal fault provable in the bankruptcy. He points out that s 82 does not talk about breach of fiduciary duty, and that there is a very real distinction between a breach of trust and a breach of fiduciary duty; in particular the solicitor who commits a breach of fiduciary duty does not have property vested in him. Again, equitable compensation can under no stretch of the imagination be classed as unliquidated damages but, even if it could be so classed, then the claim did not arise by reason of contract, promise or breach of trust.

Dr Bennett QC commenced with the words of James LJ in Ex parte Llynvi Coal & Iron Co; Re Hide (1871) LR 7 Ch App 28 at 31–2, where his Lordship said on the Bankruptcy Act 1869 (Imp):

A great number of cases occurred, before the passing of the late Act, in which the bankrupt was left liable to several claims of various kinds, and the persons who had those claims were entirely excluded from any participation in the general division of the assets. Then came the Act of parliament, which — dealing in express terms with almost every one of the cases which had ever previously occurred, and excluding nothing but demands for damages for personal torts — provided that there should be nothing whatever for which a right of proof should not be given. Every possible demand, every possible claim, every possible liability, except for personal torts, is to be the subject of proof in bankruptcy … The broad purview of this Act is that the bankrupt is to be a freed man — freed not only from debts, but from contracts, liabilities, engagements and contingencies of every kind.

Dr Bennett QC then relies on Britter v Sprigg (1900) 26 VLR 65 at 82, where the Victorian Full Court dealt with the Insolvency Act 1890 (Vic). In that case the Full Court held that the wrongful receipt by a director of a building society of moneys of the society by way of commission constituted a debt provable in insolvency. At 82 Madden CJ said:

We think, upon interpretation of s 114 of the Insolvency Act 1890, that this obligation is one provable in insolvency. We think that upon the verbiage of the statute the section is one which, though confused and indefinite, is exceedingly comprehensive, and that this obligation is a debt provable in insolvency. This opinion is confirmed by the case of Emma Silver Mining Co v Grant (1880) 17 Ch D 122, wherein it is declared that the obligation of a director who is in a fiduciary position may be considered that of a contractor, so that he must observe the principles of his trust and not contravene them, and that a breach of his obligation not to make such a payment as this would be a breach of trust. We think the relationship of a director to his company is on this principle contractual. It is therefore within s 114.

I should note that s 114 of the Victorian 1890 Act provided that: “Demands in the nature of unliquidated damages arising otherwise than by reason of a contract or promise shall not be provable in insolvency.” However, the Emma Silver Mining Co case is also authority for the proposition that a secret commission is a fraud from which a bankrupt is not released under s 153(2)(b).

At least if there is a breach of trust in the strict sense, these principles have never been departed from: see, for more recent examples, Cutten and Harvey v Mount (1988) 14 ACLR 662 at 667 and Re Vassis; Ex parte Leung (1986) 9 FCR 518 at 527.

McPherson on Company Liquidation, 3rd ed, p 375, truly says:

The tendency is to give a narrow interpretation to the exclusionary aspect of s 82(2) and the following claims have been held to fall outside its scope: claims in respect of secret profits for breach of fiduciary duty, for profits made by infringing a patent, for damages in respect of misrepresentation inducing a contract, or rectification of the share register, and for contribution against a joint tortfeasor. In addition there is a general principle that a person with alternative remedies in contract and tort may elect to waive the tort and prove in contract …

McPherson then refers (p 380) to Re Southern Cross Coaches Ltd (1932) 49 WN(NSW) 230, where in a bus collision passengers in the bus of the company being wound up were able to prove because their claim arose out of a contract made with the bus company to carry them safely, whereas claims by passengers in the other bus were excluded from proof because they lay purely as a matter of personal tort. (emphasis added)

The width of the section is further illustrated by the cases discussed by the High Court in Gye v McIntyre (1991) 98 ALR 393 ; 171 CLR 609 at 632 and following. It seems to me that Dr Bennett QC's submissions on this point have to be accepted. The case in tortious negligence is one that arises out of a contract or promise in the sense that it was failure to fulfil the promise to protect. It does not seem to me that it matters that there was no cause of action in contract because there was no promise for consideration. It is sufficient that there is a claim at law or in equity and that that claim is for damages which arises out of a contract or promise. Likewise, the cases to which I have referred show that it does not matter that the claim should properly be classified as equitable compensation.

19                  However, the approach taken subsequently by the Victorian Court of Appeal was that regardless of the contract of retainer between a solicitor and a client, a claim in negligence could still be characterised as an unliquidated claim for damages in negligence because the contract was not an essential element of the claim.  Charles JA observed in Aliferis v Kyriacou (2000) 179 ALR 477 at [46]-[51]:

[46]     Notwithstanding this endorsement of the decision in Chittick, in so far as the judgment suggests that the present claim is one for a provable debt and accordingly not excluded from the general release provided by s 82(1), I would, with great respect, not follow it. It seems to me rather that the correct test to apply for the purpose of deciding whether a demand is within the exclusion provided by s 82(2), leaving breach of trust to one side, is whether a contract or promise constitutes an essential element of the cause of action. In a claim for unliquidated damages for professional negligence against a solicitor, the pleading of the retainer will often, if not usually, be necessary, but only for the purposes of delineating and defining the scope of the professional's duty of care. For reasons such as those given by Lord Wright in Grant's case the pleading of the contract or retainer, however, is not an essential element in the cause of action.

[47]     Mr Stuckey also relied on Emma Silver Mining Co v Grant; Jack v Kipping and Britter v Sprigg in support of his submissions that the language of s 82(2) is not directed at causes of action, but rather at the cause or basis of the demand and that the proper approach is to examine whether the demand arises by reason of a contract, even though the cause of action giving rise to liability is not for breach of contract.

[48]     In each of these cases the claim was regarded as provable, but, in my view, each is distinguishable. In Emma Silver Mining the claim was “in the nature of an ordinary debt due by an agent in respect of money had and received by way of secret profit” and was so treated by Sir George Jessel. The claim was not for unliquidated damages and was regarded as arising under a contract. Jack v Kipping was a claim for unliquidated damages for a fraudulent misrepresentation which induced the claimant to contract to purchase shares. Cave J, speaking for himself and Mathew J said that:

It is said that such a fraudulent misrepresentation is a tort; but we think that it is not a personal tort, but a breach of the obligation arising out of the contract of sale.

This decision was doubted by McLelland CJ in Eq in Re NIAA Corp Ltd (in liq) where his Honour said of the passage just quoted:

Whether this assimilation was justifiable for the purpose of the “mutual dealings” provision, the application of which is limited to provable claims, is questionable, particularly as no attention was paid in that case to the decision in Ex parte Baum. However, the real thrust of the decision seems to have been that to deny a set-off in the circumstances of that case “would be inequitable”, which suggests that the decision should properly be treated as illustrating the availability in those circumstances of an equitable set-off, making reliance on the “mutual dealings” provision and the question of whether the claim was provable in the bankruptcy, otiose.

Plainly there were other considerations bearing upon the decision in Jack v Kipping. In Britter v Sprigg it was held, following Emma Silver Mining, that the wrongful receipt by the director of a building society of moneys of the society by way of commission, being both a breach of trust and contractual, constituted a debt provable in insolvency within the meaning of s 114 of the Insolvency Act 1890.

[49]     I should add that in In the Estate of Fitzhardinge (dec'd); Ex parte Hely, Manning J held that a right of action against a bankrupt solicitor for not duly prosecuting an action for his client was in substance for negligence, and damages for such negligence were not capable of proof under s 45(1) of the Bankruptcy Act 1887 (NSW).

[50]     In the judgment now under appeal, the learned judge preferred the decision of Young J in Chittick to that of Manning J in Fitzhardinge. His Honour said that the exception in s 82(2) should be read very narrowly, relying on Ex parte Llynvi Coal and Iron Co and continued:

The duty relied upon by the plaintiff in the present case only arose by reason of the existence of the contract between the plaintiff, her husband and the defendant. That is clear from the pleadings. The duty and the terms of the retainer are the same. It is clear, therefore, that the plaintiff's claim is a demand which arises by reason of a contract.

[51]     The statement of claim did indeed include an allegation that the plaintiff and her husband retained the defendant, as well as pleading some of the terms of the retainer. But I do not accept that the plaintiff's claim in negligence is therefore a demand which arises by reason of a contract. In my view the contract does not constitute an essential element in the plaintiff's cause of action in negligence, and her tortious claim is “a demand in the nature of unliquidated damages arising otherwise than by reason of a contract promise or breach of trust” within the meaning of s 82(2) of the Bankruptcy Act. It was therefore not provable in the defendant's bankruptcy and the plaintiff was not required to obtain leave from the Federal Court of Australia before pursuing it. (footnotes omitted)

20                  The High Court came to consider Aliferis 179 ALR 477 in Coventry v Charter Pacific Corporation Ltd (2005) 227 CLR 234.  The opening paragraphs of that decision indicate the consequences of the correct characterisation:

4          If the claim for unliquidated damages made pursuant to the Corporations Law is a debt provable in that person's bankruptcy, discharge from bankruptcy operates to release that person from that claim.  If it is not a debt provable in the bankruptcy, discharge from bankruptcy does not operate to release the bankrupt from the claim and, subject to any question of limitation of actions, the claim can be pursued against the former bankrupt after discharge.  Moreover, s 58(3) of the Bankruptcy Act 1966 (Cth) does not prevent the claimant, during the bankruptcy, from commencing a legal proceeding in respect of the claim or enforcing any remedy against the person or the property of the bankrupt in respect of that claim.  The sub section denies such competency to a creditor only in respect of "a provable debt".

5          The central question in the appeal hinges on the meaning of s 82(2) of the Bankruptcy Act 1966 and, in particular, what is meant by a demand in the nature of unliquidated damages arising otherwise than by reason of a contract or promise.  That expression, used to identify an exception to the definition of debts provable in bankruptcy, has been held not to include a claim for unliquidated damages for fraudulent misrepresentation which induced the party misled to make a contract with the bankrupt (a "bilateral" case).  That is, such a claim for damages has been held to be a debt provable in the bankruptcy, and a claim that was to be set off against a claim by the bankrupt estate.  But a claim for unliquidated damages for fraudulent misrepresentations where the representations induced the claimant to make a contract with another (a "tripartite" case) has been held not to be a claim provable in the bankruptcy.  The bankrupt having made no contract with the party who claims damages from the bankrupt, the claim for damages for fraudulent misrepresentation has been held to be a demand arising otherwise than by reason of a contract or promise.

6          These reasons demonstrate that a statutory claim for unliquidated damages for misleading or deceptive conduct which induced the claimant to make a contract not with the bankrupt but with a third party is not a debt provable in bankruptcy.  It is a demand in the nature of unliquidated damages arising otherwise than by reason of a contract or promise.  The bankrupt is not discharged from liability.  The claim may be pursued by the claimant during the bankruptcy and after discharge from bankruptcy.  By contrast, a claim for unliquidated damages for misleading or deceptive conduct by the bankrupt, which induced the claimant to make a contract with the bankrupt, would be a debt provable in bankruptcy. (footnotes omitted)

21                  To move forward in the judgment to the topic most relevant to the current issue (at [64]), the High Court rejected the principle reasoning expressed by the Court of Appeal in Victoria in Aliferis 179 ALR 477 which in turn had been followed in a number of subsequent cases:

[64]     Aliferis was a bilateral case. It concerned a claim, pleaded in both contract and tort, by a client against a solicitor alleging negligent performance of a retainer. The solicitor entered a deed of arrangement under Pt X of the Bankruptcy Act but the client (the plaintiff in the action) did not participate in the arrangement. Was the client’s claim a debt provable in bankruptcy?

[65]     The Court of Appeal of Victoria held that the claim was one arising otherwise than by reason of a contract and thus not a claim provable in the solicitor’s bankruptcy. The court held that a claim arises by reason of a contract or promise only if a contract or promise is an “element” or “essential element” of the cause of action. Charles JA, with whose reasons the other members of the court agreed, held that the pleading of the contract of retainer was not an essential element of the cause of action in negligence.

[66]     Two points must be made about this conclusion and the reasoning underpinning it. First, the decision appears to proceed from an assumption that, despite the way the case was pleaded, the claim actually pursued was framed only as a claim in tort. It is not necessary to examine whether, in the particular circumstances of that case, the assumption was well founded. Even if the assumption was well founded, Jack v Kipping reveals that framing a claim as a claim in tort does not conclude the question whether the demand arises by reason of a contract or promise.

[67]     The second and more important point is that the test stated in Aliferis, and applied by the Court of Appeal in the present matter, to decide whether a demand arises by reason of a contract or promise does not satisfactorily reflect the meaning to be given to s 82(2). It should not be adopted or applied.

[68]     The test stated in Aliferis does not give any weight to the need to read s 82(2) in the light provided by the set-off provisions of s 86. It is a test which does not distinguish between bilateral and tripartite cases. It treats as the critical question whether the claimant must plead the existence of a contract, any contract. It treats as irrelevant whether the bankrupt was a party to the contract.

[69]     Further, to express the relevant test in the way it was in Aliferis places heavy emphasis upon the way in which the particular claim is or could be pleaded. That may serve only to mask what is to be understood by the reference to “element” or “essential element”. Thus, in the present case, this formulation of the test provoked debate about whether the manner in which Charter Pacific alleged that it had suffered damage (by performance of contractually stipulated obligations) was an “essential element” of the claim for damages for misleading or deceptive conduct. Approaching the problem in that way shifts attention away from the statutory test to subsidiary questions about proper pleading practice.

[70]     What is revealed by the analysis of decided cases recorded in the preceding pages of these reasons is that s 82(2) and its legislative predecessors stopped short of providing that “the bankrupt is to be a freed man — freed not only from debts, but from contracts, liabilities, engagements, and contingencies of every kind” (emphasis added). Some claims stand outside the reach of the statute. Although consideration of the application of the set-off provision required the inclusion, within the class of debts provable in bankruptcy, of those claims for unliquidated damages for fraudulent misrepresentation which had induced the making of a contract between the bankrupt and the claimant, the words of the section were not and are not to be stretched to encompass every other kind of claim which a person may have against the bankrupt.

22                  Prior to dealing with Aliferis 179 ALR 477, in its analysis in Coventry227 CLR 234, the High Court also supported its reasoning by reference to the set-off provisions in the Act.  Again the historical analysis was detailed but the following extract is in point:

Set-off in bankruptcy

30        The history of the balancing accounts in bankruptcy and the development of the rights of set off in bankruptcy, together with the competing theories respecting their origins, were considered by Powell JA in Gye v Davies.  For a very long time, the right of set off in bankruptcy has not rested on the same principles as the right of set off between solvent parties.  The latter right was given by the Statutes of Set off of 1729 and 1735 (2 Geo II c 22 s 13 and 8 Geo II c 24 s 4) to prevent cross action.  Separate provision was made for set off in bankruptcy, first in 1705 (4 & 5 Ann c 17), continued in 1732 (5 Geo II c 30), and re enacted in 1825 (6 Geo IV c 16).

31        In Forster v Wilson, Parke B remarked that the right of set off given by the Georgian statutes of set off was to prevent cross actions between solvent parties in respect of legal debts due to each in his own right.  His Lordship contrasted the statutory set off in bankruptcy as given "not to avoid cross actions, for none would lie against assignees [in bankruptcy], and one against the bankrupt would be unavailing, but to do substantial justice between the parties, where a debt is really due from the bankrupt to the debtor to his estate".  The 1825 statute (6 Geo IV c 16) was a consolidating statute which replaced the various statutes which until then had set out the law of bankruptcy.  Section 50 was confined to mutual credits and mutual debts but went on to say that "every Debt or Demand hereby made proveable against the Estate of the Bankrupt, may also be set off in manner aforesaid".  A provision to like effect appeared as s 171 of the Bankruptcy Law Consolidation Act 1849.

32        Writing of the decisions given in this period, Derham states:

Sometimes, when the courts held that a particular claim could not be employed in a set off pursuant to the 1825 or the 1849 set off section, the justification was that the demand was not provable, although this was not always the case.  There are instances in which the courts instead had regard to the definition of mutual credit adopted in Rose v Hart as a means of rejecting an argument for a set off.

This emphasis upon the requirement of mutuality is to be seen in the later nineteenth century cases to which further reference will be made later in these reasons.

33        In the 1869 English Act the reach of the set off provision was extended to "other mutual dealings".  Section 39 provided that:

Where there have been mutual credits, mutual debts, or other mutual dealings between the bankrupt and any other person proving or claiming to prove a debt under his bankruptcy, an account shall be taken of what is due from the one party to the other in respect of such mutual dealings, and the sum due from the one party shall be set off against any sum due from the other party, and the balance of such account, and no more, shall be claimed or paid on either side respectively; but a person shall not be entitled under this section to claim the benefit of any set off against the property of a bankrupt in any case where he had at the time of giving credit to the bankrupt notice of an act of bankruptcy committed by such bankrupt and available against him for adjudication.

Again, the provision made in s 86 of the Bankruptcy Act 1966 for set off is evidently based on the model of the 1869 English Act.  Section 86 (again in the form in which it stood when Charter Pacific commenced its action) provided:

(1)        Subject to this section, where there have been mutual credits, mutual debts or other mutual dealings between a person who has become a bankrupt and a person claiming to prove a debt in the bankruptcy:

(a)        an account shall be taken of what is due from the one party to the other in respect of those mutual dealings;

(b)        the sum due from the one party shall be set off against any sum due from the other party; and

(c)        only the balance of the account may be claimed in the bankruptcy, or is payable to the trustee in the bankruptcy, as the case may be.

(2)        A person is not entitled under this section to claim the benefit of a set off if, at the time of giving credit to the person who has become a bankrupt or at the time of receiving credit from that person, he had notice of an available act of bankruptcy committed by that person.

34        For present purposes, what is important to notice is that the set off provisions found in both Acts are engaged where there have been mutual dealings between the bankrupt and another person proving or claiming to prove a debt in the bankruptcy.  The set off cases therefore cast light upon what debts are provable in bankruptcy.  And what an examination of the nineteenth century cases will reveal is that the set off provisions were used to extend the reach of debts provable in bankruptcy by giving to the expression "demand in the nature of unliquidated damages arising … by reason of a contract or promise" a more ample operation than the words might at first have been thought to suggest.

…

50        Why should this understanding of s 31 of the 1869 English Act be carried over to the construction of s 82(2) of the Bankruptcy Act 1966?  Again, there are two related reasons.  First, the text of s 82, like its legislative ancestors, shows that not all claims are provable in bankruptcy.  Some content must therefore be given to s 82(2) and its reference to demands "arising otherwise than by reason of a contract, promise or breach of trust".  Secondly, any amplification or extension of the content to be given to s 82(2), beyond the immediate operation conveyed by reference to demands arising by reason of a contract or promise, is to be fixed by reference to the operation of other provisions of the statute, and particularly the set off provisions of s 86.  A claim which may be made in answer to a claim which the bankrupt estate makes for damages for breach of a contract between bankrupt and claimant may be provable.  That answering claim may be provable because it arises out of the mutual dealing or bilateral relationship of contract between bankrupt and claimant.  By contrast, a claim which comes from a tripartite transaction, in which the bankrupt's misrepresentation induced the claimant to make a contract with a third party, does not arise from a mutual dealing and it arises otherwise than by reason of a contract or promise.

51        It is against the background provided by these nineteenth century English cases that the Australian cases must be considered.  Not only is the drafting of the relevant provisions of the Bankruptcy Act 1966 for all practical purposes identical to the statutory language considered in those cases, there is the same need to work out the relationship between the provision for what debts are provable in bankruptcy (s 82) and the provision for set off (s 86).  (footnotes omitted)

23                  The present circumstance may be governed by the view of the majority of the High Court in Coventry 227 CLR 234 to the effect that ‘Jack v Kipping (1882) 9 Qbd 113 reveals that framing a claim as a claim in tort does not conclude the question whether a claim arises by reason of a contract or promise’:  see Coventry at [66]. 

24                  From this, does it follow in the present circumstances that Chittick 118 ALR 728 and Re Sharp [1998] FCA 1367 are to be taken as establishing that although Mr Lovell pursues his claim in tort, it is nevertheless a claim which arises by reason of the contract (the retainer) or even a promise (express or implied)?  The High Court in Coventry227 CLR 234 rejected the process of reasoning which examines whether or not reliance on a claim in contract is an essential element of the claim.  Does it follow that the law reverts to that as stated in Chittick 118 ALR 728, namely, that although the claim is pleaded in tort, it is also a claim rising by reason of the contract of retainer?  If so, then it would a provable debt and leave would be required under s 58(3)(b) of the Act.

25                  In short, I take Coventry227 CLR 234 to emphasise that the historical development of the Act and its predecessors is such that the class of claims that are provable will be very wide and conversely, the exceptions under s 82(2) of the Act cover a class of claims that is narrow.  While Coventrywas not dealing with a claim like the present which is in negligence alone against a solicitor, the rationale developed in the decision would appear to me to support a conclusion that such a claim is provable. 

26                  The Official Trustee’s submission to the effect that a claim in tort would not be provable carries some weight.  But this is a claim which has a contractual nexus by virtue of the retainer.  It also involves mutuality of dealings and a set-off (by virtue of the contest between Mr Lovell and Mr Penkin having originated in Mr Penkin suing for outstanding unpaid fees) and finally, arises from a one-on-one or bilateral rather than tripartite relationship.  All those elements, in light of the High Court’s rejection of the ‘essential element’ test, would cause me to have doubts as to the submission by the Official Trustee that no leave is required. 

Section 117 of the Act

27                  It is common ground between the parties to this proceeding that it is a requirement to obtain a practicing certificate in all jurisdictions and that the practitioner hold appropriate insurance against liabilities incurred in practice. 

28                  Section 117 of the Act now provides that where a bankrupt has incurred a liability against which he or she was insured, the right of indemnity vests in the trustee and the amount received from the insurer should be paid forthwith to the party to whom the liability has been incurred.  The Official Trustee contends that this is not a proper basis on which to determine the issues arising in this application as there is nothing before the Court about the extent of the insurance held by Mr Penkin.  Indeed, it is argued that there is nothing to say that the insurer has agreed to indemnify Mr Penkin on the basis of the terms in the policy of insurance.  In that case, the burden would fall on the bankrupt estate to meet the claim by Mr Lovell against Mr Penkin.  Secondly, the Official Trustee contends that if a claim for negligence against a legal practitioner were found to be provable in all cases, it is conceivable that an insurer may review its position in relation to bankrupt practitioners, knowing that a claim of negligence may be met from the proceeds of the practitioner’s estate and/or discharged by the bankruptcy. 

29                  Both of these outcomes, it is submitted, would be contrary to a broader consideration of public policy if the practical benefit of the claim of negligence against a practitioner by a member of the public could be defeated by the practitioner declaring himself or herself bankrupt. 

30                  In light of the conclusion I have reached, it is unnecessary to resolve these issues.  I have some reservations about some aspects of this argument but to the extent that I may have reservations, I think the situation is best dealt with by the granting of leave on conditional terms.  I also note that the insurer has not been heard on any of these matters, although it was aware of these proceedings.  There is precedent for such a course, for example, Kattirtzis v Zaravinos [2001] FCA 1158. 

Conclusion

31                  Although the High Court overruled the ‘essential element’ test relied upon in Aliferis 179 ALR 477, there remains some uncertainty at present as to whether the words in s 82(2) of the Act ‘… by reason of the contract, promise or breach of trust’ dictate that a direct claim in negligence only – not in contract - by one client against his or her solicitor, is provable.  That outcome may be ‘anomalous’ as the High Court accepted its conclusion was as to the proper construction of s 82(2) in Coventry 227 CLR 234.  But the emphasis in Coventryon the narrow basis of exceptions to provable claims may well support the conclusion that such a claim is provable.  Further, if there is insurance cover – and there has been no suggestion to the contrary - then the effect of s 117 of the Act is now that the benefit of that cover would still be received by the claimant rather than the estate as a whole. 

32                  For these reasons, I consider leave is required and certainly should be given so that the claim can be resolved if possible in the Supreme Court.  That said, there may come a time when these matters require further consideration and possibly further input from the Official Trustee and possibly other parties.  That input may be required even in the course of the proceedings in the Supreme Court and, if so, I consider that Mr Lovell as the claimant should not preclude that intervention by the statutory officer.  I consider that an undertaking to that effect should be required to be given by Mr Lovell to the Court in conjunction with the granting of leave for the further steps in the claim to proceed.  By the time the matter ultimately returns to this Court for further consideration (if it does) hopefully the law on this contentious issue may have been clarified and with the benefit of more comprehensive argument, there may be greater clarity as to the appropriate route to take. 

33                  I am of the view that in the circumstances just described the better course is that adopted by the Full Federal Court in Allanson 30 FLR 108 at 115, following the portion cited above:

We consider that it is unnecessary in the circumstances for us to express a final view of the effect of the stay on the operation of s. 58(3). Where a court is given power to grant leave to perform a particular act or pursue a particular course of action and the question whether the need for such leave has arisen involves difficult and complicated questions of law or fact, it is permissible, in an appropriate case, to proceed on the basis that such leave is necessary rather than involve the parties in the futile exercise of determining, possibly after a series of appeals, whether the need for such leave has arisen. In all the circumstances including the urgency of the matter, we consider that that is the appropriate course to adopt in this case and that we should, to the extent necessary, grant leave to Midland Credit to continue and take fresh steps in the proceedings in the Supreme Court of New South Wales. This approach would, it seems to us, be consistent with that adopted by the High Court in Talga Ltd. v. M. B. C. International Ltd. [1976] HCA 22; (1976) 133 CLR 622. It is an approach which was raised before us in the course of argument but not before the learned judge below. (at p 115)  (footnotes omitted)

34                  For similar reasons the orders I will make are that:

1.                  To the extent such leave is necessary by reason of the provisions of s 58(3) of the Bankruptcy Act 1966 (Cth), that Avon Francis Lovell have leave to continue and take fresh steps in proceedings instituted by him in the Supreme Court of Western Australia against Kevin Michael Penkin in action CIV 2355 of 2005 (the Action). 

2.                  The granting of leave is conditional upon the applicant, Mr Lovell, undertaking to the Court in writing within 14 days that:

(a)        he will not seek final relief in the Action without having given seven days notice to the office of the Official Trustee;

(b)        he will not oppose any application by the Official Trustee to be joined or heard in the Action.

3.                  Such leave does not extend to the taking of any step to enforce any judgment obtained in the Action without leave first being obtained from this Court. 

4.                  There be no order as to costs, subject to the following order.

5.                  If any party wishes to make submissions which differ from the costs order made in the previous paragraph, written submissions should be filed and served within 14 days. 

Associate:

Dated:         9 May 2008