A recent NSWSC decision of Kunc J in HBSY Pty Ltd v Lewis (NSWSC 2022) considered whether the assignee of the bankrupt’s share of the residuary of a deceased estate was entitled to receive that share without accounting for the loss occasioned by the bankrupt to the deceased estate when he intermeddled with its funds.

The case required the Court to consider the application of statutory and equitable principles of set-off and whether proof of the bankrupt’s state of mind is required to establish that a claim against a bankrupt for fraudulent breach of trust under s153(2)(b) of the Bankruptcy Act 1966 (Act) is not released on discharge from bankruptcy.

Key Takeaways

Statutory set-off under s86 of the Act does not apply to beneficial entitlements under a will. Equitable set-off can apply.

Under s153(2)(b) of the Act, establishing fraudulent breach of trust does not require proof of the bankrupt’s state of mind.

Brief Facts

Marjorie Lewis died (Deceased) and left a will (Will). Her estate fell into residue (Estate). There were five residuary beneficiaries under the Will – the Deceased’s brother (Allan) and Allan’s four sons (including Anthony and Geoffrey).

The Will named Allan and Anthony as executors. However, they renounced their executorship before obtaining probate. Letters of administration were granted to Geoffrey.

Anthony, purporting to act as executor of the Estate, opened an estate account with Lewis Securities Limited (Lewis Securities), a company of which he was the majority shareholder and director. Anthony deposited into this account $571,084.93 representing a significant portion of the funds of the Deceased’s Estate (Estate Funds).

In the events which followed: Lewis Securities went onto voluntary administration; Allan and Anthony each renounced their executorship of the Estate (neither had ever been granted probate of the Will) and Geoffrey was granted letters of administration with the Will annexed.

Anthony then became bankrupt. The Estate submitted a proof of debt in Anthony’s bankruptcy claiming ‘$300,000 to $330,000’ and an additional claim of $300,842 for ’wastage’ said to have been caused to the Estate by Anthony’s conduct. The calculations omitted Anthony’s residual share of the Estate from the amount claimed to be owing. The trustee formally recorded the Estate’s proof of debt for $300,000.

Anthony’s bankruptcy trustee assigned Anthony’s assets including any interest he had in the Deceased’s Estate to HBSY Pty Ltd (HBSY) for $275,000.

Following his discharge from bankruptcy, Anthony became the registered owner of all of HBSY’s share capital.

HBSY sued Geoffrey to recover Anthony’s residuary share of the Estate. Geoffrey cross claimed against HBSY alleging that Anthony had acted as an intermeddler and breached his duties (including fiduciary) duties as trustee of the Estate when he caused for the Estate Funds to be paid into the Lewis Securities account, which resulted in significant loss to the Estate.

At issue was whether HBSY should be barred from claiming Anthony’s share under the Will.

Geoffrey argued that as Anthony was an intermeddling trustee-beneficiary, he had already received his beneficial entitlement by handling the Estate Funds (relying on Re Dacre¹) and could not claim his share of the residue until after he had paid back the Estate Funds (relying on Morris v Livie² and Cherry v Boultbee³). He otherwise relied on statutory set-off under s86 of the Act.

HBSY argued that statutory set off does not apply to beneficial entitlements under wills and that any claim the Estate had against Anthony was either extinguished when it proved in his bankruptcy or when he was discharged from bankruptcy.

Decision

The Court held that Anthony had acted as intermeddler when he dealt with the Estate Funds and that his renunciation as executor ineffective. Anthony was liable to account to the Estate for the loss occasioned to it by his conduct. This presented a significant problem for HBSY because it took Anthony’s interest in the Estate subject to equitable principles.

The Court agreed that statutory set-off arising under s86 of the Act did not apply because a beneficial entitlement under a will is a gift and not a ‘dealing’ of a business or commercial nature for the purposes of s86, relying on Gye v McIntyre (HCA 1991) and Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (In Liq) (Recrs and Mgrs Apptd) (WASCA 2018).

As for the application of the equitable principles established by Re Dacre, Morris v Livie and Cherry v Boultbee, the Court held that:

• Under Re Dacre, Anthony was taken to have been paid his entitlement at the time he breached his obligation as trustee. When HBSY purchased Anthony’s interest, there was nothing left in Anthony’s entitlement for HBSY to claim because he had already received it in the misappropriated funds.
• Under Morris v Livie, Anthony’s interest in the Estate was extinguished at the time he breached his obligations to it. When HBSY purchased Anthony’s interest, it had already ceased to exist. The interest can only be reinvigorated by curing the default by repayment.
• Under Cherry v Boultbee, Anthony is taken to already be in receipt of his share. HBSY is unable to claim the interest until it is released by repayment of the default in full.

The Court held that as the Estate’s proof of debt claimed the amount due to the Estate net of Anthony’s share of the residue, it had only waived its claims against Anthony to the extent of what it had claimed and received in dividends from Lewis Securities ($385,662.71). The Court concluded that the Estate was entitled to rely on equitable principles to seek to recover the balance from the bankrupt.

The final issue to determine was whether the Estate’s equitable claims against Anthony was ’a debt incurred by means of fraud or a fraudulent breach of trust’ so that they were not extinguished on his discharge from bankruptcy. This required the Court to determine whether ’fraudulent breach of trust’ for the purposes of s153(2)(b) of the Act requires proof of the bankrupt’s state of mind.

Neither the UK nor the Australian cases on point provided a neat answer to the question.

His Honour concluded that he was bound to follow the dispositive Australian case of Maxwell v Chittick (NSWCA 1994) which held that fraud in the equitable sense does not require the defendant to have an actual intention to defraud the plaintiff. Having already concluded that Anthony had committed a breach of trust, his Honour did not need to consider whether Anthony was unaware of his breach or whether he had acted with good intentions when he meddled with the Estate Funds. He concluded that the Estate’s claims against Anthony for fraudulent breach of trust were not extinguished upon Anthony’s discharge from bankruptcy.

Geoffrey’s cross claim against HBSY was upheld. HBSY as assignee of Anthony’s interest is unable to receive any funds from the Estate until his breach is made good by repaying to the Estate the remainder of the debt. Anthony’s masterplan to get his hands on the Estate’s funds failed abysmally.

Implications

Assignees should carefully scrutinise a claim by a trustee-beneficiary under a will before taking any assignment of it.

Take care when completing proofs of debts. The outcome for the deceased estate in this case may have been very different had it proved for the whole value of the Estate’s claims against the bankrupt in its proof of debt.

¹ Re Dacre; Whitaker v Dacre [1916] 1Ch 344
² (1842) 62 ER 934
³ [1839] EngR 1099