By Bonnie McMahon, Solicitor, of Matthews Folbigg, in our Insolvency, Restructuring and Debt Recovery Group
Creditors frustrated by a debtor entering into bankruptcy or a composition should remember that some claims can continued to be pursued, even after the debtor becomes bankrupt or enters a deed of composition with his or her creditors. Debtors in such actions may also need to be aware that going bankrupt may not bring the claims to an end.
Justice Emmett of the Supreme Court of New South Wales has provided some useful guidance in these matters.
The proceedings in the matter of Ritchie v Woodward (Executor of the Estate of the late Brian Patrick Woodward); Rujo Pty Ltd v Woodward (Executor of the Estate of the late Brian Patrick Woodward); Barona Group Pty Ltd v Woodward (Executor of the Estate of the late Brian Patrick Woodward)  NSWSC 1715 (“Ritchie”), proved to be anything but simple for his Honour, with a hearing lasting four weeks (a week longer than expected), and an array of legal topics covered including: contracts, professional negligence, misleading and deceptive conduct, vicarious liability, bankruptcy and insurance claims.
In this matter, Tony Woodward (“Mr Woodward”), a chartered accountant and a former bankrupt, was sued by former clients (“the plaintiffs”), who claimed that Mr Woodward had:
- Breached his retainer agreement;
- Breached a duty of care owed to them under the general law; and
- Engaged in misleading and deceptive conduct under the provisions of the Fair Trading Act 1987 (NSW) (“the Fair Trading Act”).
The plaintiffs’ claims against Mr Woodward and the other associates of his accounting practice, related to a number of transactions in which Mr Woodward had acted for the plaintiffs. Justice Emmett addressed each claim separately, finding that neither Mr Woodward nor his associates were liable in respect of the claims made by the plaintiffs. Despite reaching this conclusion, Justice Emmett decided to address a number of other issues which had been raised in the proceedings, including the likely effect that Mr Woodward’s annulled bankruptcy would have had on the proceedings, had the Court found in favour of the plaintiffs.
The Bankruptcy Issues
Mr Woodward became a bankrupt on 1 July 2010, following the acceptance of his debtor’s petition by the Official Receiver. A year later, Mr Woodward entered into a composition with his creditor under section 73 of the Bankruptcy Act (“the Composition“). In accordance with section 75(2) of the Bankruptcy Act, the Composition was binding on all creditors in respect of the debts provable in Mr Woodward’s bankruptcy. Once accepted, the effect of a composition under the Bankruptcy Act is to immediately annul the bankruptcy and (once completed) release all debts owing to creditors of the bankrupt estate.
Not surprisingly Mr Woodward therefore said that the Composition released him from all claims made against him in the proceedings. In response to this, the plaintiffs argued that their current claims against Mr Woodward had not been released by the Composition, as their claims were excluded from being provable by section 82(2) of the Bankruptcy Act. Section 82(2) states that “[d]emands in the nature of unliquidated damages arising otherwise than by reason of a contract, promise or breach of trust are not provable in bankruptcy.” As such, if it could be proven that the plaintiffs’ claims were unliquidated, and arose other than by reason of contract, promise or breach of trust, then the Composition would not be binding on the plaintiffs’ under section 75.
The plaintiffs accepted that one of their claims, relating to a breach of the retainer agreement, was not excluded under section 82(2), as it arose out of a contract, and was thus caught by the composition. However they did not believe this would be the case for their remaining two claims (relating to breach of a general law duty, and breach of the Fair Trading Act 1987 (NSW)).
Jurisdiction of the Supreme Court
Before answering any specific questions relating to Mr Woodward’s bankruptcy, the Court needed to establish whether the Supreme Court had the jurisdiction, to determine the question of the effect of the composition on the plaintiffs’ claims (“the Question”).
The Federal Court and Federal Circuit Court have concurrent jurisdiction in bankruptcy, exclusive of all courts (other than the High Court and Family Court in some circumstances), under section 27 of the Bankruptcy Act. Despite this, the Supreme Court can be vested with federal jurisdiction to hear bankruptcy matters and the Question in this case, under section 4 of the Jurisdiction of Courts (Cross-Vesting) Act 1987 (Cth) (“the Cross Vesting Act”). The vesting of this jurisdiction will automatically occur under section 4, provided the matter is not a “special federal matter”: section 6(1) of the Cross Vesting Act. If the matter is a “special federal matter” the Supreme Court can still hear the matter, provided there are special reasons for doing so, and an order is made by the Supreme Court under section 6(3) of the Cross Vesting Act.
“Special federal matters” in s 3 of th Cross Vesting Act are matters within the original jurisdiction of the Federal Court – as determined by section 39B of the Judiciary Act 1903 (Cth), and will include any matter arising under the Bankruptcy Act. However Justice Emmett noted that there is an important distinction between “exercising jurisdiction by simply recognising the effect of the Bankruptcy Act on the property of a bankrupt, on the one hand, and exercising jurisdiction in any matter arising under the Bankruptcy Act, on the other” (at , emphasis in the original). His Honour was satisfied that it was central to the jurisdiction in bankruptcy was the authority to decide whether a particular claim was a provable debt in the bankruptcy.
However, his Honour held that the task before him was akin to determining the “status of a proceeding commenced by a person who subsequently becomes bankrupt” and which his Honour held is a matter that must “necessarily be addressed by the court in which the proceedings has commenced” (at ).
Justice Emmett held that question before him “necessarily impacts on the status of the proceedings before the Supreme Court” so that the Court has jurisdiction to answer the question.
The question of the jurisdiction of different courts in bankruptcy matters continues to be a complicated matter.
Is it a Bird, or is it a Plane?
When considering whether an unliquidated claim is excluded from being a provable debt under section 82(2), consideration must be had to the nature of the claim. If the claim relates to professional negligence, such as the one in Ritchie, the court will identify “whether the claim is a demand arising otherwise than by reason of a contract or promise” (at ).
However claims alleging professional negligence invariably also allege a breach of contract, whenever a client has engaged a professional adviser. So does the professional negligence claim arise “by reason of a contract”?
In order to answer this question, the court will look at the form of the pleadings filed by the plaintiff. If the claim in the pleadings “is shown to arise by reason of a contract or promise, that must be sufficient to exclude the operation of s 82(2)” (at ), and the claim will be provable.
After analysing the pleadings relating to the plaintiffs’ professional negligence claim, Justice Emmett found that the pleadings relied on the accounting services provided to the plaintiffs by Mr Woodward, “in the ordinary course of carrying out the business of the Partnership.” The Court found that the use of this terminology in the pleadings made it clear that the alleged duty of care arose out of a contractual relationship between the parties, and would have been caught by the Composition, although the Court did not need to decide the point.
In relation to the plaintiffs’ statutory claim of misleading and deceptive conduct, Justice Emmett drew a distinction with the professional negligence claims. If the claims based on the statute “do not, as a matter of substance, depend upon the existence of a contract or promise, s 82(2) will not be enlivened” (at ).
Previously (at ) his Honour had noted “the anomaly” that a misleading and deceptive statement by the bankrupt, which induced a person to enter into a contract, would not be a claim arising by reason of a contract, if the contract was with a third party, but would fall within the exception to s 82(2)(and thus be provable), if the contract was with the bankrupt.
In the case of Mr Woodward, his Honour found that the matter was “somewhere between those two cases” (at ). However on a review of the pleadings Emmett AJA noted that the representations which were said to have been misleading and deceptive because they were made “in the provision of services” to the plaintiffs “in the ordinary course of carrying out the business of the Partnership.” This suggested to his Honour that the liability was “dependent upon the existence of a contractual relationship” (at ). As such, the potential liability of Mr Woodward and the partnership in relation to the Fair Trading Act claim, nevertheless arose by reason of the contract between the debtor’s Partnership and the plaintiff. Justice Emmett then went on to suggest that if he had to make a decision on this point, it may follow that section 82(2) would not be enlivened, as this claim also arose out of a contract.
The Effect of Ritchie
The decision in Ritchie highlights the complicated relationship between claims and provable debts. Just because someone has become bankrupt or entered into a composition with creditors, does not mean that the claims will come to an end. Creditors, and those contemplating bankruptcy, will be well advised to seek specialist legal advice on the implications of a possible personal insolvency on unliquidated legal claims.
Read the judgment here.
If you would like more information or advice in relation to insolvency, restructuring or debt recovery law, contact Bonnie McMahon at firstname.lastname@example.org or a Principal of the Matthews Folbigg Insolvency, Restructuring & Debt Recovery Group:
Jeffrey Brown on (02) 9806 7446 or email@example.com
Stephen Mullette on (02) 9806 7459 or firstname.lastname@example.org.