Many of you will be familiar with the decision in Tang & Anor v. Bassili & Ors [2011] FMCA 544, in which the Federal Magistrate’s Court said that the ATO could not use a garnishee notice to hijack the proceeds of sale of a mortgaged property.

Last Friday, that decision was overturned on appeal, and the proceeds of sale of the property concerned were ordered to be paid to the ATO, instead of the mortgagee.
However, for the reasons set out below, this development is not as alarming as it might initially seem.

 

The facts

The factual background to last Friday’s decision was as follows: –

1. Mrs. Bassili owned some land in Fig Tree Pocket, a suburb of Brisbane. Her land was subject to two mortgages – a first mortgage to the National Australia Bank, and a second mortgage to a company called Instyle Developments Pty. Limited.
2. Mrs Bassili owed each of these companies a lot of money – so much, in fact, that Instyle was expecting to suffer a shortfall when the property was sold. Mrs. Bassili also owed about $75,000 to the ATO.
3. In January 2010, a contract for the sale of the property was entered into.
4. The ATO found out about the contract and promptly served a garnishee notice on the purchasers, requiring them to pay approximately $75,000 directly to the ATO.
5. Understandably, Instyle objected to this. It wanted the money for itself – it was already destined to suffer a shortfall and it was not enthused by the prospect of that shortfall worsening by $75,000. Consequently, urgent negotiations ensued between Instyle, the purchasers, the ATO and the newly-appointed trustee of Mrs. Bassili’s estate, during which: –
   1. Instyle refused to discharge its mortgage unless it received all of the surplus sale proceeds;
   2. the purchasers refused to pay any money to Instyle unless the ATO withdrew the garnishee notice; and
   3. the ATO refused to withdraw the garnishee notice.
6. Settlement was due to proceed on 18 February but did not go ahead, due to Instyle’s refusal to discharge its mortgage.
7. Thereafter, further urgent negotiations were conducted, as a result of which Instyle ultimately agreed to discharge its mortgage on condition that the disputed funds would be paid into a trust account and held in escrow pending resolution of the issue of who, as between Instyle and the ATO, had the better entitlement to payment. Settlement occurred on that basis on 23 February.
8. Court proceedings were eventually commenced in the Federal Magistrate to determine the crucial issue. At the same time, as a result of a side deal between the trustee and Instyle, Instyle assigned any interest in the money to the trustee, who essentially stepped into Instyle’s shoes for the purpose of the proceedings.

The decision in the Federal Magistrates Court

Against that background, the Federal Magistrates Court in Tang v. Bassili was called upon to decide who, as between the ATO and the trustee (as assignee of the rights of Instyle), had the better claim to the money. After hearing each party’s submissions it sided with the trustee, reasoning as follows: –

1. If a person has a floating charge over a debt, and that charge crystallises, the debtor is required to pay the charge-holder directly, and the debt is no longer payable to the original creditor.
2. The situation in the present case is basically the same – Instyle’s mortgage over the property really meant that there was never really any money owing to Mrs. Bassili for the ATO to garnishee.
3. The commercial reality of the situation was that the money was being generated by the sale of Instyle’s security, and was therefore really owing to Instyle.
4. Consistently with that reasoning, the Federal Magistrate’s Court found that the disputed funds should be paid to the trustee, as assignee of the rights of Instyle.

The ATO was not satisfied with the decision, and appealed to the Full Court of the Federal Court.

 

The arguments in the Full Court

Before the Full Court of the Federal Court, the ATO argued that the circumstances of the case were nothing like the floating charge analogy adopted by the Federal Magistrate.

It submitted that the money was owed at all times by the purchasers to Mrs. Bassili, and the fact that she might direct that the money be paid to her mortgagee instead of her did not alter that fact – and nor did the fact that the money was the proceeds of sale of an asset in which she had no equity.

In response, the trustee argued (and this will strike a chord with most lawyers, insolvency practitioners and, above all, financiers) that you just can’t do what the ATO was trying to do: –

1. You cannot have a situation where a mortgagee is sitting there, quite happy and secure, and the next day the ATO turns up with a garnishee notice and unceremoniously turfs the mortgagee out.
2. Such a finding would, the trustee anxiously submitted, be the end of civilisation as we know it. Commercial and consumer lenders, languishing in uncertainty, would simply refuse to lend money to anyone, the Australian economy would shudder to a halt, and we would be beset with complete economic meltdown.

Let’s pause there to consider this argument.

Surely the trustee must be right? It would be a massive shake-up for commercial life in Australia if an unsecured debt that had arisen after an existing secured debt could “jump the queue” and sit in front. Sure, land tax can do that, but that is a predictable, regular and comparatively minor cost, and anyway we’re used to it.

Tax debt is completely different: sometimes, the ATO doesn’t even know it’s owed money until it sends in an auditor – and then hundreds of thousands of dollars of surprise tax debt gets raised and shunted onto the Running Balance Account overnight.

If such debts were allowed, by means of a garnishee notice, to jump the queue and sit in front of mortgagees, that would completely stuff up the whole system. The apocalyptic scenario envisaged by the trustee was really no less alarming than the trustee presented it to be.

 

The Full Court’s analysis

Fortunately, however, the Full Court was able to allay the trustee’s concerns, by pointing out that it was really Instyle’s fault that it lost its money – and within Instyle’s control all along to prevent that loss.

The Full Court did not agree with the Federal Magistrate’s view that the situation was analogous to the crystallisation of a floating charge, because nothing in a “direction to pay” makes the debt legally owed by the purchaser to the mortgagee. It is simply not the same as the crystallisation example seized upon by the lower court.

The Full Court also pointed out that nothing the ATO did undermined Instyle’s mortgage. The mortgage was still sitting there, and if it wanted to Instyle could have refused to discharge it – as it did to start with. Therefore, it was not correct to say that the ATO’s garnishee notice sat in front of the mortgage: all it did was countermanded the vendor’s direction to pay.

It may be that that resulted in a stalemate. However, as the Full Court pointed out, Instyle could have out-manoeuvred the ATO by taking possession of the property and selling it as mortgagee in possession. If it did that, then no money would ever be payable to Mrs. Bassili and consequently the garnishee notice would have nothing to attach to.

The Armageddon-like scenario posited by the trustee was, consequently, a furphy. There was therefore no overriding public policy reason to quash the garnishee notice, so the Full Court upheld it and directed that the $75,000 in court be paid to the ATO (Commissioner of Taxation v Park [2012] FCAFC 122.

 

Where does this leave us?

Having regard to the Full Court’s analysis, it is apparent that Instyle’s big mistake was to agree to discharge its mortgage. The moment it did that, it lost its security. There is considerable discussion of this in the majority decision – Instyle’s argument that there was a residual equitable interest that survived discharge of the mortgage and carried through to the proceeds of sale was not accepted.

In short, and with reference to the title of this bulletin, the ATO did not trump the mortgagee – it trumped itself. What it should have done instead was stick to its guns and ensure the ATO withdrew the garnishee notice before it discharged its mortgage.

Alternatively, if the ATO refused to withdraw its garnishee notice, Instyle should have taken possession of the property and effected a sale as mortgagee in possession. If it did that, then there really would have been no money payable to Mrs. Bassili. The purchase price would have been payable directly to Instyle, and the garnishee notice would have had nothing to attach to.

So why did Instyle not do these things – and why was the ATO so nasty to it anyway? One can only guess. It may be that the ATO suspected a clandestine connection between Instyle and Mrs. Bassili, that meant that Instyle was not really an innocent third party after all. This aspect of the matter is not dealt with in either decision, and the reader is left to speculate.

 

Moving forward

We expect that the ATO will eventually publish a “Decision Impact Statement” about the decision in Park, explaining that it does not intend to march in and scupper every settlement involving a delinquent taxpayer, and assuring the nervous public that this newly-discovered weapon in the tax collection arsenal will only be deployed sparingly.

In the meantime, secured lenders should be warned not to release their security upon the sale of goods or land when the ATO has sought to intercept the purchase price with a garnishee notice. As a result of Friday’s decision in Park, it is now clear that the advisable course in such circumstances is: –

1. to negotiate for the withdrawal of the notice; or
2. alternatively, to effect a sale of the subject property as mortgagee in possession (or through a receiver) so that no part of the purchase price becomes payable to, or at the direction of, the delinquent taxpayer.