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Are equitable charge holders secured creditors for the purposes of the Bankruptcy Act 1966 (CTH)?

In June 2017, the Full Court of the Federal Court of Australia1 in Morris Finance Ltd v Brown [2017] FCAFC 97 handed down its decision on the appeal from the New South Wales Supreme Court’s decision in Morris Finance Limited v Free, Trustee of the Property of Neil Warren Brown, a Bankrupt [2016] NSWSC 516.

Issue

Both of the above decisions of the Full Court and the New South Wales Supreme Court were limited to the determination of the preliminary question being:

  • “Does the plaintiff require the leave of the Court (within the meaning of the Bankruptcy Act 1966 (Cth) (Act)) to commence the proceeding or to take any fresh step in the proceeding” (Preliminary Question).

The question alternatively could be posed as whether a legal proceeding seeking to realize or enforce an equitable charge through judicial process falls within section 58(5) of the Act and therefore does not require leave under section 58(3)(b).2

The New South Wales Supreme Court at first instance found in the affirmative; leave was required.

The Preliminary Question was to be determined as part of proceedings where the equitable charge holder, Morris Finance Ltd (MFL) was seeking orders, among other things, that:

  • The affected real property be sold;
  • Vacant possession of the affected real property be delivered up;
  • Orders as to the manner of sale of the affected real property; and
  • How the proceeds of sale were to be distributed.

(Proprietary Orders)

Facts

The Appellant, MFL, claimed to be the holder of an equitable charge over real property located at 16A Petrie Street, Coopernook, New South Wales (Property). The Property was owned by Mr and Mrs Brown (the Browns). The equitable charge is alleged to have been created pursuant to a commercial goods lease between MFL and Mr Brown dated 3 January 2012 (Good Lease).

Mrs Brown also gave a guarantee in favour of MFL to secure the performance of Mr Brown’s obligations to MFL under the Goods Lease.

MFL asserted that the Browns’ equitable charge, granted in respect to the Property, secured the performance of their obligations to MFL.

Mr Brown became bankrupt on 17 June 2013.  Mrs Brown became bankrupt on 25 August 2015. The respondents to the appeal included a first ranking mortgagee and the Browns respective trustees in bankruptcy.

An amount exceeding $45,000 was alleged to be owed to MFL under the Goods Lease.

The existence of the equitable charge was disputed.

The Appeal

Interestingly from a procedural perspective (as was discovered by the appellant3), pursuant to section 7(5)(a) of the Jurisdiction of Courts (Cross-vesting) Act 1987 (Cth), as the matter for determination was by way of an appeal from a decision of a single judge of the NSW Supreme Court involving the Act (which is specified in the Schedule) the appeal had to be heard by the Full Court of the Federal Court.

The relevant section of the Act under scrutiny is extracted as follows:

Section 58 of the Act:

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

(a)  ……..; 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.

(4)………..

(5)  Nothing in this section affects the right of a secured creditor to realize or otherwise deal with his or her security.

Section 5(1) of the Act contains the following relevant definitions:

  • “provable debt” means a debt or liability that is, under this Act, provable in bankruptcy; and
  • “secured creditor”, in relation to a debtor, means:

“(a)       ……………..        

(b)         in the case of any other debt – a person holding a mortgage, charge or lien on property of the debtor as a security for a debt due to him or her from the debtor.”

The Court noted the importance of sections 58(3)(b) and 58(5) of the Act to equitable charges such as that claimed by MFL, observing that “If the decision below had been correct, it would be difficult for a secured creditor whose equitable charge was disputed to seek to enforce it through a State court without first obtaining leave under sections 58(3)(b), an unnecessary and disadvantageous impediment to the charge“.4

In its analysis, which included a brief history of the evolution of sections 58(3) and 58(5) of the Act, the Full Court observed that:

  • Whilst the Act did not define “security”, it defined “secured creditor”5, which relevantly includes “a person holding a mortgage, charge or lien on property of the debtor as a security…” The Full Court found that there is no reason that the interpretation of the term “secured creditor” be limited to that of the holder of a legal interest only;
  • Given the broad scope of the interpretation of the definition of “secured creditor” and the terms of section 58(5) there is no basis to exclude the holder of an equitable charge from the benefit of the operation of section 58(5) in terms of the exercise of a holder’s rights to “realize or otherwise deal with” its equitable charge; and
  • There are differing rights conveyed by an equitable charge (solely by agreement) when compared with that of a registered mortgage (which will usually have additional statutory rights attached).The rights of an equitable charge holder as to enforcement are distinct by their limitation. Equitable charge holders, having no access to self help remedies, are reliant upon judicial orders to affect a sale. This exposes a charge holder to the uncertainty that may arise when seeking to invoke a court’s equitable jurisdiction as there may be discretionary matters to be considered.

The Full Court ultimately found, contrary to the findings of the court below, that:

  • Reliance upon section 85(5) does not require that an equitable charge first be established or that if challenged, the charge holder is to be kept out of the benefit of section 85(5);
  • Section 58(5) is to be construed “relatively liberally”;
  • MFL, as the holder of an equitable charge, had the benefit of section 85(5) of the Act and therefore did not need to seek leave before seeking the Proprietary Orders;
  • The Proprietary Orders sought were akin to legal proceedings brought by a mortgagee seeking possession of a mortgaged property. The equitable charge holder is seeking to exercise its “right of realization by judicial process6 and there is no reason for MFL to be treated differently to the holder of mortgage; and
  • The interpretation of “secured creditor” and “security” extends to an equitable charge holder. If the conduit for enforcing a charge holder’s remedies is limited to judicial process, the words of section 58(5) “to realize or otherwise deal with his or her security” are sufficiently broad to include the Proprietary Orders.

It must be remembered that the Full Court’s decision did not determine the ultimate validity of the equitable charge. The Full Court focused upon the Preliminary Question only. The validity of the charge returned to the New South Wales Supreme Court for determination. The benefit of the decision rests not only with respect to procedural matters arising from the operation of the Jurisdiction of Courts (Cross-vesting) Act 1987 (Cth), but on following the Full Court’s approach to interpreting section 58 of the Act in the context of its appreciation of the sections operational importance.

This article was written by Kyle Somann-Crawford, Partner, in our Hobart office.

Publication Editor: Grant Whatley.

1The full Bench was made up of Beach,  Markovic And Moshinsky JJ
2Morris Finance Ltd v Brown [2017] FCAFC 97 at para 1
3Morris Finance Ltd v Brown  [2016] NSWCA 343 at para 44 per Payne JA with Basten JA at [1] agreeing
4Morris Finance Ltd v Brown [2017] FCAFC 97 at para 8
5Section 5(1) of the Act
6Morris Finance Ltd v Brown [2017] FCAFC 97 at para 44 (where reference is made to Heenan J’s phrase in Evenwood Pty Ltd v Conway [1997] WASC 14).

Important Disclaimer: The material contained in this publication is of a general nature only and is based on the law as of the date of publication. It is not, nor is intended to be legal advice. If you wish to take any action based on the content of this publication we recommend that you seek professional advice.