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Finance & Banking Update -  October 2005

In this issue: Read about the latest cases in the world of banking and finance.

Cases

• Chattel securities - bills of sale - covenant to insure property - relief against forfeiture (Beaudesert Metal Fabricators Pty Ltd v Beaudesert Shire Railway Support Group Inc [2005] QSC 17) Supreme Court of Queensland, Atkinson J
• Ship mortgage - registration procured by fraud - indefeasibility of title (Advertising Department Pty Ltd v The Ship 'MV Port Phillip' [2004] FCA 1762) Federal Court of Australia, Finkelstein J
• Bankruptcy - extra-territorial operation of legislation - Cayman Islands (Al Sabah v Grupo Torras SA [2005] UKPC 1) United Kingdom Privy Council
• Guarantees and indemnities - characterisation of security instrument (Marubeni Hong Kong and South China Ltd v Mongolian Government [2005] EWCA Civ 395) English Court of Appeal
• Misrepresentation - emerging markets investment product - synthetic derivative (Peekay Intermark Limited v ANZ Banking Group [2005] EWHC 830 (Comm)) English High Court
• Caveats - defect in drafting - protection of floating charges (Hanson Construction Materials Pty Ltd v Vimwise Civil Engineering Pty Ltd [2005] NSWSC 880) Supreme Court of New South Wales, Campbell J
• Administration - subscribing shareholders as creditors - induced to subscribe by fraud (Crosbie (in his capacity as administrator of Media World Communications Ltd (admins appt'd) and Media World Broadcasting Pty Ltd (admins appt'd) v Naidoo [2005] FCA 51) Federal Court of Australia, Finkelstein J
• Subscribing shareholders as creditors - alleged breach of s729 - the rule in Houldsworth's case (Cadence Asset Management Pty Ltd v Concept Sports Ltd [2005] FCA 1280) Federal Court of Australia, Finkelstein J
• Administration - transferee shareholders as creditors - s563A Corporations Act (Sons of Gwalia (Administrator Appointed) (ACN 008 994 287) v Margaretic [2005] FCA 1305) Federal Court of Australia, Emmett J

Chattel securities - bills of sale - covenant to insure property - relief against forfeiture (Beaudesert Metal Fabricators Pty Ltd v Beaudesert Shire Railway Support Group Inc [2005] QSC 17) Supreme Court of Queensland, Atkinson J

As part of a deed of company arrangement, a mortgagor gave security under a bill of sale to a group of creditors. The deed required the bill to be executed by all creditors before it could be enforced, however the bill was not signed by a number of them. Covenants in the bill required the mortgagor to insure the secured property. The creditors sent letters requesting the mortgagor to furnish them with certificates of currency for insurance policies taken out over the property. When these requests were not complied with the creditors brought an action seeking possession of the secured property. In evidence it was proved that the property was not insured for a certain period of time.

The mortgagor argued that the court should grant relief from forfeiture under its equitable jurisdiction or pursuant to s95(3) of the Property Law Act 1955 (Qld), on the grounds that the breach of covenant was a mere administrative error and that no damage was caused by the breach. Furthermore, the bill was unenforceable because a condition precedent to its enforcement was that all creditors had signed it.

The creditors won.

Section 95(3) gives the court discretion to grant relief where the mortgagor has undertaken to remedy the breach of covenant and has tendered payment for the breach. In this case, the mortgagor could not remedy the breach because such a remedy would involve obtaining insurance for a period which has passed, which cannot be achieved. Therefore s95(3) was not satisfied.

Atkinson J did not accept the submission that the breach was a mere administrative error because the creditors made a number of requests for certificates of insurance, which would have brought the deficiency to the mortgagor's attention. Furthermore, the operations conducted by the mortgagor were hazardous, making the breach particularly serious. Hence relief was not granted under the court's equitable jurisdiction.

It was unnecessary for the bill to be executed by all creditors because it was registered with the Office of Fair Trading. Section 20(2) of the Bills of Sale and Other Instruments Act 1955 (Qld) provides that once a bill is registered it has the effect of and is taken to be a deed properly executed by all the parties. This was not a case in which a condition precedent to enforcement was proper execution by creditors. As indicated by clause 49 of the bill, the mortgagor was immediately bound upon signing the bill.

A copy of the case is available to view.

Ship mortgage - registration procured by fraud - indefeasibility of title (Advertising Department Pty Ltd v The Ship 'MV Port Phillip' [2004] FCA 1762) Federal Court of Australia, Finkelstein J

Two parties formed a partnership for the purpose of purchasing a yacht. The first partner was granted an unregistered goods mortgage by the second partner, giving the first partner legal title over the yacht subject to the second partner's equitable right of redemption. The second partner fraudulently registered the yacht in his own name with the Australian Register of Ships, pursuant to s14 of the Shipping Registration Act 1981 (Cth). He then granted a registered mortgage over the yacht to a mortgagee in consideration for a loan. The second partner defaulted on the loan and the mortgagee sought to recover its debt. Upon discovering the fraud, the first partner sought a declaration that its unregistered mortgage had priority over the mortgagee's registered mortgage and an order that the register be rectified.

The mortgagee won.

Finkelstein J noted that the Australian Act was almost identical to the Merchant Shipping Act 1894 (UK) (the English Act). It was therefore necessary to review a history of the English Act and those cases which applied the legislation. The English authorities can be distilled into the following principles with respect to the priorities of interests in ships:

1. equitable interests (such as unregistered mortgages) are enforceable despite the system of ship registration;
2. a registered owner will be bound by any equitable interest created by him or her, or which came into existence by reason of his or her conduct;
3. the registered title of a bona fide purchaser for value without notice cannot be impeached;
4. a later registered interest takes priority over an earlier unregistered interest; and
5. where a purchaser enters a contract for sale and receives notice of an earlier unregistered interest after entry into the contract, the purchaser's interest takes priority.

The fundamental principle is that the register is everything. If a person in good faith acquires an interest in a ship from the registered owner, that person will obtain indefeasible title which will defeat any prior unregistered interest, irrespective of whether the prior interest is legal or equitable. Such an interest will prevail even where the interest was created by fraud, provided the interest holder was not party to, or had knowledge of, the fraud.

It follows that the mortgagee's interest, which was obtained through a registered owner (the second partner), took priority over the first partner's interest, because the mortgagee was not party to, and did not have knowledge of, the fraudulent act of the second partner.

A copy of the case is available to view.

Bankruptcy - extra-territorial operation of legislation - Cayman Islands (Al Sabah v Grupo Torras SA [2005] UKPC 1) United Kingdom Privy Council

Background

A Kuwaiti man defrauded a Spanish company out of a very large amount of money and was found liable for substantial damages by an English court. He was declared bankrupt and in subsequent proceedings the Bahaman trustee in bankruptcy sought to recover property to which the bankrupt was beneficially entitled under trusts settled in the Bahamas and the Cayman Islands. The trustee was granted an ex parte order from a Bahaman court which set out a request for aid from the Grand Court of the Cayman Islands. The request was for the trustee to be recognised in the Cayman Islands jurisdiction and granted various powers accorded to a trustee under the jurisdiction's bankruptcy legislation. These powers included the power to claw back settlements of property such as that held on trust for the bankrupt.

The Grand Court acceded to the request on the grounds that s156 of the Bankruptcy Law of the Cayman Islands (the Cayman Islands Act) and s122 of the Bankruptcy Act 1914 (UK) (the UK Act) authorised the court to act on the request, and that the court should as a matter of discretion or according to its inherent jurisdiction act on the request.

The bankrupt claimed the Cayman Islands court should not have accepted the Bahaman court's request.

The trustee won. The Cayman Islands court's exercise of discretion was unobjectionable.

Section 122 of the UK Act provided for mutual assistance between Jamaican and 'all the [British] courts' in bankruptcy matters. Section 156 of the Cayman Islands Act is almost identical to the UK Act and it is unlikely that any divergence was intended. However, the Cayman Islands only has one bankruptcy court and so the phrase 'all the courts' in s156 does not have any practical effect. It follows that the court could not have accepted the request on the basis of s156.

At first glance s122 would apply to the Cayman Islands proceedings. However, the bankrupt argued the Insolvency Act 1985 (UK) (the Insolvency Act) repealed s122 in its entirety or partly, leaving it in force only with respect to certain countries. The court rejected this argument, stating that s235(3) of the Insolvency Act repealed the entire UK Act except ss121-123.

The final issue was whether s122 conferred upon the Cayman Islands court the power to make the orders that it did. The court found that s122 should be interpreted broadly, so that courts can provide assistance to one another even where their respective powers are not identical. The court agreed with the reasoning in Radich v Bank of New Zealand, an Australian case applying s29 of the Bankruptcy Act 1966 (Cth), that s122 envisages importing a hypothetical bankruptcy in the receiving state with the same features as a bankruptcy in the requesting state. Therefore the exercise of discretion was permitted.

Guarantees and indemnities - characterisation of security instrument (Marubeni Hong Kong and South China Ltd v Mongolian Government [2005] EWCA Civ 395) English Court of Appeal

A vendor agreed to supply a Mongolian purchaser with textile plant and machinery. The agreement was backed by a letter from the Mongolian Minister for Finance. The letter stated that the government unconditionally pledged to pay the amount due upon simple demand from the vendor. However, the wording of the letter also indicated that the government would only become liable once the amount becomes due and payable for the purchaser. Furthermore, the letter was referred to in later correspondence by the government as a guarantee. The vendor and purchaser altered their financing arrangements following a dispute. The government claimed this was a material variation of the agreement such that its obligations under the letter were discharged.

The government won. The obligations under the letter were discharged as a result of the variation in financing arrangements.

As a starting point, the rule in Holme v Brunskill states that a guarantee is discharged if the obligations it secures are materially varied without the guarantor's consent. However, both parties agreed that the rule only applies to instruments creating secondary obligations such as guarantees, and does not apply to primary obligations such as demand bonds or their equivalent.

Predictably, the vendor argued that the letter created a primary obligation. It claimed that words such as 'unconditional' and 'simple demand' in the letter and the express waiver of any right to require the vendor to proceed against the buyer reflected a primary, independent obligation.

The government claimed the letter was a secondary obligation, observing that outside the field of demand instruments and performance bonds issued by banks, courts have not been willing, in the absence of clear words, to interpret such documents as imposing unconditional primary liability.

The Court of Appeal explained that demand bonds were developed by the banking world as a specialised form of irrevocable instrument and noted that the letter in issue was not a banking instrument. Nor was the letter couched in terms appropriate to a demand bond. If the vendor had wanted the additional security of a demand bond, one would expect it would have insisted on express language in both the letter and the legal opinion indicating it imposed such an obligation. The words 'unconditional' and 'simple demand' were insufficient for this purpose in light of qualifications in the letter and the description of the letter in the legal opinion.

Misrepresentation - emerging markets investment product - synthetic derivative (Peekay Intermark Limited v ANZ Banking Group [2005] EWHC 830 (Comm)) English High Court

A bank had an ongoing relationship with a private banking client. The bank advertised to the client a new product it had developed which gave investors an interest in Russian Treasury short-term non-interest bearing bonds (GKOs), denominated in roubles, with the benefit of a US dollar hedge. The bank representative dealing with the client, and the client himself, both believed the product gave an interest in GKOs, meaning that in the event of default the client would have control over liquidation of the interest and would be left holding roubles. This description of the product was provided in the Indicative Terms and Conditions (ITCs) which were sent to and signed by the client. However, the true nature of the investment was a synthetic interest with returns linked to a reference obligation. If the Central Bank defaulted the bank would pay the client an amount equal to the market value of the reference obligation and the client would have no option of restructuring the investment. This description of the product, which was neither read by the bank representative nor the client, was provided in the Final Terms and Conditions (FTCs), each page of which was initialled by the client and returned to the bank. The FTCs made no reference to the client, only the bank and its local subsidiary and the Contract Note which recorded the transaction contained a litany of errors.

During the term of the investment the Russian government announced a moratorium on GKO debt obligations. This constituted an event of default under the FTCs, requiring the bank to sell the reference obligations on market, yielding 2.3% of the client's original investment, which was credited to his account.

The client claimed the bank had misrepresented the nature of the investment and that he would not have invested but for the misrepresentation. The bank claimed he had contracted on the basis of the FTCs and hence had not been induced by any misrepresentation.

The client won.

The court found that the product had clearly been misrepresented in the ITCs. The bank representative and the client both believed the investment was consistent with the ITCs and that if any material changes had been made to the nature of the investment, the bank would have brought this to the attention of the representative and the client. The client had placed great confidence in the bank as his private bankers and had no cause to believe the FTCs would diverge in any way from the ITCs.

The bank argued that in order to make out the their claim, the client must show a misrepresentation of the FTCs themselves, because those became the terms of the contract. The court disagreed, finding no principle of law preventing a party to a written contract for the sale of a product from claiming damages for misrepresentation where the party was induced to enter the contract by a pre-contractual misrepresentation as to the nature of the product sold.

The court was satisfied that the client was induced to invest by the misrepresentation, particularly as to the ability to restructure. This was borne out by the fact that he had retained other investments affected by the Russian default in the hope their values would recover.

Caveats - defect in drafting - protection of floating charges (Hanson Construction Materials Pty Ltd v Vimwise Civil Engineering Pty Ltd [2005] NSWSC 880) Supreme Court of New South Wales, Campbell J

A chargee took security from a property developer in relation to the provision of credit for the purchase of gravel. The instrument stated that 'as security for payment…the [developer] charges…all of the [developer]'s interests in freehold and leasehold property both current and later acquired'. The charged land consisted of two properties which were each already encumbered by two registered mortgages granted in respect of large loans to the developer. The chargee lodged caveats over both properties, specifying in the caveat that it had an 'equitable interest' in the properties. The developer decided to refinance the loans and sought to remove the caveats. The developer argued that the security instrument created a floating charge and that a floating charge is not a caveatable interest. Alternatively, the caveat fell foul of s74F of the Real Property Act 1900 (NSW) because it failed to specify the particulars of the equitable interest.

The developer won. The caveat was declared invalid and removed.

The characterisation of a charge as fixed or floating depends on the intentions of the parties. A charge which attaches to property acquired during the term of the agreement will generally be fixed unless circumstances suggest there is an intention that it be floating. In Boambee Bay Pty Ltd v Equus Financial Services such a charge was found to be floating because the assets of the business of the chargor were such that, if the charge was fixed, carrying on business would be difficult if not impossible. By contrast, in this case the chargee knew nothing about the developer's business other than that it was a property developer. It followed that there was no reason to depart from the ordinary wording of the charges and the charge was characterised as fixed. The court therefore did not need to consider whether a floating charge creates a caveatable interest.

The description 'equitable interest' was not specific enough for the purposes of s74F because there are a multiplicity of interests in land which are equitable. This was a fundamental defect in the drafting of the caveat which could not be cured by s74L (which permits minor defects to be overlooked). For this reason the caveat was invalid and was ordered to be removed.

Administration - subscribing shareholders as creditors - induced to subscribe by fraud (Crosbie (in his capacity as administrator of Media World Communications Ltd (admins appt'd) and Media World Broadcasting Pty Ltd (admins appt'd) v Naidoo [2005] FCA 51) Federal Court of Australia, Finkelstein J

A company issued a prospectus to raise capital in order to expand its operations and exploit a new technology. Soon after the successful capital raising, doubts were raised as to the effectiveness of the company's technology and the share value plummeted, leading to the appointment of an administrator. A number of shareholders decided to bring a claim based on deceit and negligence and under the Fair Trading Act 1999 (Vic) and Australian Securities and Investments Act 2001 (Cth). They claimed the prospectus contained false statements which induced them to take up shares in the company. The administrator applied to the court for guidance on whether these shareholders were creditors for the purposes of the administration.

The shareholders were not creditors for the purposes of the administration.

The administrator was of the view that the shareholders were not creditors. He stated that a creditor for the purposes of part 5.3A is a person who has a debt which, if the company were in liquidation, would be admitted to proof under s553(1). Because the shareholders would (potentially) be creditors in their capacity as shareholders, s563A would subordinate their claim such that they could not admit their claim for proof.

Finkelstein J rejected this view, stating that s563A was irrelevant in the present case. That provision is concerned with priorities, which in these circumstances would be determined by the creditors in their deed of company arrangement.

The rule in Houldsworth's case states that a person who has subscribed for shares in a company may not, while the person retains those shares, recover damages against the company on the ground that the person was induced to subscribe for those shares by fraud or misrepresentation. Where the company is insolvent, the rights of third party creditors intervene such that a shareholder may not rescind his or her contract to acquire the shares. This means the shareholder must retain the shares and cannot bring such a claim, unless the company regained solvency.

For this reason the shareholders could not be treated as creditors.

Finkelstein J stated that an argument could have been run that the shareholders were contingent creditors who would become creditors either upon the court ruling that the shareholder contract was void by virtue of s158 of the Fair Trading Act 1999 (Vic) or the company coming out of administration. He also gave his opinion, in obiter, about the application of Houldsworth's case to shareholders who had been induced by the prospectus to purchase shares on the open market. These transferees would be in a different position because they do not have the opportunity of renouncing their shareholding as against the company, because the sale was from a third party. The House of Lords decision in Soden v British & Commonwealth Holdings plc supports this view. Hence Houldsworth's case should not be applied in such a situation.

A copy of the case is available to view.

Subscribing shareholders as creditors - alleged breach of s729 - the rule in Houldsworth's case (Cadence Asset Management Pty Ltd v Concept Sports Ltd [2005] FCA 1280) Federal Court of Australia, Finkelstein J

A shareholder subscribed for shares in a company through a prospectus which forecast the company would make a large profit. Within two months the shares lost 70% of their value after announcing the company would in fact record a large loss. The shareholder subsequently sold the shares, incurring a loss. The shareholder, as representative for a group of similar shareholders, claimed that the prospectus omitted information required under s710 of the Corporations Act 2001 (Cth) and that the forecasts for sales revenue and earnings were misleading and deceptive in breach of s729 of the Act. These breaches induced the shareholder to subscribe. Damages were sought for the difference between the sale price of the shares and the subscription price.

The company claimed that the shareholder could not sustain its claim due to the rule in Houldsworth's case. As the shareholder had not renounced its shares as against the company, it could not sue for damages for a fraud or misrepresentation which induced the subscription.

The shareholder argued that Houldsworth's case only applies to common law claims for damages and not to statutory causes of action, and in particular not a claim under s729.

The company won.

In considering whether Houldsworth applied to claims under s729 the following factors pointed in favour of overturning the case:

• The cause of action conferred by s729 is remedial in nature and should therefore be given broad effect;
• Section 729 is in terms unrestricted, and to impose a limitation would be inconsistent with its terms; and
• If s729 has not overturned Houldsworth, it would have little scope.

However, Finkelstein J found a number of factors, which favoured upholding Houldsworth, more persuasive:

• Parliament could have but did not in terms overturn Houldsworth;
• Parliament is aware of Houldsworth and its consequences and when it wishes to do it will overturn its effect and do so in clear language;
• A similar argument was made and rejected in Webb Distributors v Victoria in relation to s52 of the Trade Practices Act 1974 (Cth); and
• Houldsworth has been given effect by s563A and to overturn it would be inconsistent with that provision.

Hence the shareholder's claim was barred by Houldsworth. Interestingly, Finkelstein J did not make reference to his decision in Media World earlier in the year (see above), which made a similar finding. However, he did reiterate the comments made in Media World, and adopted in Sons of Gwalia (see below), that transferee shareholders induced to purchase on-market would be in a different position to subscribers.

A copy of the case is available to view.

Administration - transferee shareholders as creditors - s563A Corporations Act (Sons of Gwalia (Administrator Appointed) (ACN 008 994 287) v Margaretic [2005] FCA 1305) Federal Court of Australia, Emmett J

A shareholder purchased shares in a mining company on-market. A few days later, the company released information to the market that its gold reserves were insufficient to satisfy its current gold delivery commitments and had appointed an administrator. The shares instantly became worthless. The shareholder claimed that, in failing to disclose the inadequacy of its gold reserves prior to his purchase, the company breached its continuous disclosure obligations under s674 of the Corporations Act 2001 (Cth) and ASX Listing Rule 3.1 and the statutory prohibitions on misleading and deceptive conduct. If the material had been disclosed he would never have purchased the shares and suffered the loss in value.

The administrator sought a declaration that the shareholder's claims would not be provable under the proposed deed of company arrangement or that the payment of the claim under the deed would in any event be postponed until all debts owed to, and claims made by, persons not in the capacity as members had been paid.

The shareholder cross-claimed, seeking a declaration that he was entitled to be treated as a creditor for the company administration provisions in Part 5.3A of the Act.

The shareholder won.

The terms of the deed mirrored the provisions of the Act. Relevantly, s553 states that all debts payable by, or claims against, the company are admissible to proof against the company. It was common ground that the shareholder had a 'claim' within s553. Section 563A states that payments of debts or liabilities owed to members in their capacity as members are postponed until all debts or claims owed to other creditors have been satisfied.

The administrator claimed that by virtue of s563A and its parallel provision in the deed, the shareholder was prevented from proving in the administration. The administrator relied on the High Court's decision in Webb Distributors v Victoria. In that case the court found that shareholders claiming damages for being induced to purchase shares claimed in the capacity as members because the amount they sought directly related to their shareholding and they retained their shares. Their claims are thus postponed to the claims of other creditors.

Emmett J found that Webb Distributors only applied to subscribing shareholders, not shareholders who had purchased on-market. Transferee shareholders sued in a capacity other than as members. Emmett J held that if the claim is a debt at all, it arises by operation of the consumer protection provisions which prohibit misleading and deceptive conduct. Hence neither s563A nor the deed postponed the shareholder's debt or prevent the shareholder claiming as a creditor during the administration. The shareholder was permitted to exercise all the incidental rights of a creditor under the deed, including the right to attend and vote at creditors' meetings and receive information and circulars sent by the company to its creditors.

A number of other shareholders with similar claims were invited to bring short minutes of orders that they contend were appropriate for their claims, having regard to the reasons given in this case.

A copy of the case is available to view.

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