Enforcing an equitable charge against a bankrupt
Subsequent to writing this blog post, a shorter version of this case note has been published in the Australian Government’s Australian Financial Security Authority newsletter, the ‘Personal Insolvency Regulator’. A link to the publication can be found here.
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The Full Court of the Federal Court has recently clarified the law regarding the ability of a secured creditor of a bankrupt estate to commence proceedings against the bankrupt pursuant to the Bankruptcy Act 1966 (Cth). In Morris Finance Ltd v Brown,[1] the Full Court considered the provisions of the Act and held that, as an exception to the general rule that a creditor requires leave of a court to bring a claim for a provable debt against a bankrupt, proceedings to enforce an equitable charge do not require leave.
The facts
The respondents, Mr and Mrs Brown, owned real property in New South Wales. In 2012, they entered into a commercial goods lease with the applicant, Morris Finance Ltd, pursuant to which they charged their interest in the property in favour of Morris Finance in order to secure their obligations under the lease. As a consequence of this arrangement, Morris Finance claimed an equitable charge over the property.
Mr Brown became bankrupt in June 2013, and Mrs Brown in August 2015. In November 2015, Morris Finance commenced proceedings in the New South Wales Supreme Court seeking, amongst other things, an order for sale of the Browns’ property and ancillary orders regarding the sale proceeds so as to discharge a debt that the Browns owed under their lease.
At the first instance, the primary judge held that as a result of the Browns’ bankruptcies Morris Finance required leave under the Act to commence proceedings to enforce its equitable charge.
Morris Finance applied for leave to appeal that decision.[2] The key question for the Full Court was whether a proceeding seeking to realise or enforce an equitable charge through judicial means falls within section 58(5) of the Act and therefore does not require leave under section 58(3)(b).
The relevant provisions in section 58 of the Act read:
‘58 Vesting of property upon bankruptcy — general rule
…
(3) 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.
…
(5) Nothing in this section affects the right of a secured creditor to realize or otherwise deal with his or her security.
…’
The terms ‘provable debt’ and ‘secured creditor’ are defined in section 5(1). The definition of a secured creditor includes ‘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 Full Court’s analysis
Beach, Markovic and Moshinsky JJ delivered a joint decision. Their Honours stated their conclusion at the outset, namely that:
‘[I]t is contrary to the text, context and purpose of s 58(5) to exclude from its operation judicial processes to enforce an equitable charge.’[3]
In reaching its decision, the Full Court considered first whether a ‘secured creditor’ for the purposes of the Act included a creditor whose debt had been secured by way of an equitable interest.
The Court considered the legislative history of section 58 and the definition of ‘secured creditor’. Noting the breadth of the definition — it includes ‘a person holding a mortgage, charge or lien on property’ — their Honours held that ‘there is no good reason to confine any of these types of securities to legal interests as opposed to equitable interests’[4] and that at the time of the provision’s enactment such interests were well-recognised species of equitable interests.
Finding that a ‘secured creditor’ included a creditor holding an equitable interest, the Full Court turned to what it considered the more contentious question: the scope of the phrase ‘realize or otherwise deal with’ in section 58(5) and how that might bear upon the requirement to seek leave to commence proceedings with respect to an equitable charge.
Their Honours considered the nature of an equitable charge: that it is a creature of equity enforceable only in equity, and that its primary means of enforcement is a judicial order for sale of security property. Their Honours observed that ‘[t]he chargee has no self-help remedy … but must obtain the assistance of a court of equity to realise or enforce the charge’.[5]
The Full Court then posed the question:
‘Is a proceeding seeking such orders [for sale or receivership] a step to “realize” or “otherwise deal with” such a security within the meaning of s 58(5)? If so, no leave is required under s 58(3)(b).’[6]
Their Honours concluded that Morris Finance’s proceeding seeking sale of the Browns’ property fell within section 58(5) — that Morris Finance was a secured creditor and its proceeding was a step to ‘realize or otherwise deal with [its] security’ — and therefore did not require leave under section 58(3)(b). This was so for a number of reasons.
First, the Full Court noted the presence of authority permitting legal proceedings to be brought by a mortgageeseeking an order for possession of a mortgaged property for the purposes of section 58(5) and that enforcing a right to possession for the purposes of sale of the security property is an act of realisation (whether by self-help or judicial process). Their Honours did not see any distinction between an equitable mortgagee and an equitable chargee in terms of the exercise of rights over a security property; ‘[p]roceedings seeking either possession or sale or both can come within the phrase “realize or otherwise deal with his or her security”.’[7]
Second, their Honours considered that section 58(5) should be construed ‘relatively liberally’ so as to embrace judicial realisation of an equitable charge.[8]
Third, their Honours were of the view that, in light of the purpose of section 58 — to prevent the depletion of a bankrupt’s property to the advantage of individual creditors and to the disadvantage of creditors collectively — there would be no unfair advantage to a secured creditor, and no inappropriate depletion of the bankrupt’s estate, in seeking an order for sale of property over which the secured creditor had an equitable charge.
Fourth, Morris Finance had sought orders for sale of the security property rather than simply a declaration as to the existence of a security interest and the extension of a caveat over the property. For that reason, their Honours distinguished the present situation from that in Mango Media Pty Ltd v Velingos[9] where Barrett J held that such matters do not involve the exercise of a right to ‘realize’ or ‘otherwise deal with’ security property.
It was argued on behalf of the respondents that the existence of the equitable charge itself was in dispute — such matters being the subject of the New South Wales proceeding — and that this therefore precluded the operation of section 58(5). To this the Full Court made two key remarks:
The filing of a defence in response to a claim for an equitable charge does not negate the operation of section 58(5); the bringing of a proceeding (in this case, in the New South Wales Supreme Court) enlivens section 58(5) and this does not change simply because the proceeding, and the underlying claim of an equitable charge, is contested; there would be ‘considerable uncertainty’ if things were otherwise.[10]
Satisfying section 58(5) does not first require that the security interest be established, as although section 58(5) does away with the need for a security holder to obtain leave to bring its claim it does not signify proof of that claim.
Fifth, it did not matter that Morris Finance sought, in addition to an order for sale of the security property, orders regarding the proceeds of sale. Such orders were ancillary to the orders for sale and ‘[did] not seek adjudication on the quantum of the amounts but rather an endorsement of the general protocol for distribution’.[11]
Finally, the Court distinguished the present case from a situation where a judgment creditor seeks to enforce a judgment debt. In the High Court decision in Hall v Richards,[12] Taylor J observed that levying a judgment debt was distinct from realising a security.[13] In the present case, Morris Finance was a party seeking enforcement of an equitable security over property and was not an unsecured creditor seeking a means for repayment of a judgment debt.
In answer to the question put to the Full Court on appeal, ‘Does [Morris Finance] require the leave of the Court (within the meaning of s 58 of the Bankruptcy Act 1966 (Cth)) to commence the proceedings or to take any fresh step in the proceeding?’, the Court answered: ‘No’.
Conclusion
In the course of its reasons, the Full Court has provided useful guidance on the policy and operation of section 58 of the Act. The reasons should be noted for the way in which the Court distinguishes the enforcement of an equitable charge from other actions including enforcement of a judgment debt, and how this affects the issue of whether or not a creditor requires leave to bring a claim against a bankrupt.
[1]: [2017] FCAFC 516.
[2]: The primary judge’s decision was interlocutory and therefore leave to appeal was required pursuant to section 24(1A) of the Federal Court of Australia Act 1976 (Cth).
[3]: Morris Finance Ltd v Brown [2017] FCAFC 516, [8].
[4]: Ibid [36].
[5]: Ibid [38].
[6]: Ibid [39].
[7]: Ibid [47].
[8]: Ibid [48].
[9]: [2008] NSWSC 202.
[10]: Morris Finance Ltd v Brown [2017] FCAFC 516, [54].
[11]: Ibid [58].
[12]: (1961) 108 CLR 84.
[13]: Ibid 101.