What claims do you have against a transferee of a bankrupt’s property
A recent decision of the Full Court of the Federal Court1 has considered the claims that can be made against a party that has received property from a bankrupt in a transaction intended to defeat the interest of creditors but where the receiving party subsequently transferred the property to a third party for value and without notice of the claim.
The effect of the decision is that the claims that can be made are limited to tracing into the proceeds of sale of the property (which will only be possible if the receiving party has retained those proceeds) and the receiving party is not otherwise liable to compensate the trustee for the loss to the bankrupt estate (or benefit obtained by the receiving party). That is so even if the receiving party was aware of the bankrupt’s intention to defeat creditors.
The case concerned a claim pursuant to s37A of the Conveyancing Act 1919 (NSW)2 that the transaction was void as it was intended to defeat the interests of creditors but the principle is also applicable to claims under s121 of the Bankruptcy Act 1966 (Cth). The principle does not apply to claims pursued by a liquidator given the relief available to a liquidator pursuant to s588FF of the Corporations Act 2001 (Cth) includes an order requiring the recipient of the property to compensate the liquidator.
Background
Mr and Mrs Royal, together with the trustee of the bankrupt estate of Mr Nathan El Ali, commenced proceedings seeking relief under s37A of the Conveyancing Act 1919 (NSW) in relation to a series of transactions instigated by Mr Ali with the intention to defraud his creditors. The relevant transaction for present purposes concerned the Voyager Point Property.
In December 2011, the Property was transferred to a Mr Zreika for consideration of $1. The transfer was stamped but not registered at that time. When the transfer was signed, Mr Zreika also became trustee of the trust that owned the Property, although the Court found that Mr Ali continued to control the trust. Some 8 days after the transfer was signed, Mr Ali was made bankrupt.
In January 2013, the registered mortgagee of the Property was owed some $1.4m, the value of the property was $900,000 and an arrangement was made pursuant to which the mortgagee would accept $800,000. Gee Bee Airfreight lent Mr Zreika $900,000, which was used to pay the $800,000 required by the registered mortgagee. The transfer of the property to Mr Zreika which was signed in December 2011 was registered on the title on 29 January 2013. The Court found that Mr Ali was intimately involved in these transactions.
Two months later in March 2013, Mr Zreika sold the property to Pronto Properties for $1.7m, nearly double the value of the property in January 2013. The proceeds of sale were used to repay the $900,000 loan made by Gee Bee Airfreight, to repay a further $600,000 loan that Gee Bee Airfreight had made to Mr Zreika in relation to a second property and $200,000 was retained by Mr Zreika. Again, the Court found that Mr Ali was intimately involved in these transactions. Further, Pronto Properties was related to Gee Bee Airfreight, although Pronto Properties was not a party to the proceedings.
The Decision of the Full Court
The trial judge found that the intention of the transfer in 2011 was to defeat the interests of Mr Ali’s creditors. That decision was upheld on appeal. The relevant issue for the purposes of this article is the extent of the remedy that was available against Mr Zreika – was it the $800,000 that he had the benefit of from the sale of the Property (being the $600,000 loan repayment plus the $200,000 he had retained) or the $200,000 he had retained.
The Full Court confirmed that the High Court decision in Brady v Stapleton3 meant that the relief that was available was limited to the $200,000 that Mr Zreika had retained. Where a third party purchaser has acquired a property from a transferee of the fraudulent debtor, there is no personal remedy against the transferee. The only remedy available (when the property has been transferred) is a tracing remedy. This requires the defrauded creditor (or bankruptcy trustee) to identify that portion of the proceeds of sale still remaining in the hands of the transferee.
Although Mr Zreika obtained a benefit from the repayment of the $600,000 loan, he was not obliged to compensate the defrauded creditors for that benefit. It did not matter that he obtained that benefit with the knowledge that Mr Ali had transferred the Property to Mr Zreika with the intention to defeat the interests of Mr Ali’s creditors. The Full Court held that at the time of the sale of the Property for $1.7m, Mr Zreika had title to the Property even though it was potentially subject to attack by the defrauded creditors. Although the attack was later successfully maintained, it did not make the sale of the Property wrongful and impose a personal liability on Mr Zreika, as assignee of the defrauding debtor Mr Ali.
The decision was based on the parties’ effective concession that Pronto Properties was a purchaser of the Property in good faith and without notice, despite the evidence of a connection between Pronto Properties and Gee Bee Airfreight and Mr Ali’s involvement in the transactions. As Pronto Properties was not a party to the proceedings, and neither party made direct allegations against it, the Full Court was not prepared to proceed on the basis that Pronto Properties was not a purchaser in good faith and without notice.
Significance
The decision makes clear that what is important is the ability to recover the bankrupt’s (or defrauding debtor’s) property or the proceeds of sale of the property. The recipient of the property will not be liable in damages for any benefit they receive from the transaction, even if they are aware of the intention to defeat creditors. In these circumstances, it is important to act swiftly4 to protect the property (or its proceeds of sale) if there is a prospect of a claim being made.
While the decision, in terms, is limited to a transaction to defeat the interests of creditors the same principle could apply to claims in respect of undervalued transactions.
This article was written by Andrew O’Halloran, Partner and Diandra Ciacciarelli, Graduate in our Adelaide office.
Publication Editor: Grant Whatley
1 Zreika v Royal [2019] FCAFC 82 (Besanko, Farrell, O’Callaghan JJ, 23 May 2019)
2 Similar statutory provisions apply in other jurisdictions
3 (1953) 88 CLR 322
4 Including by seeking freezing orders if required