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03
Oct 2017

Creditor’s right to a “risk premium” for funding bankruptcy trustees

In the recent case of Low v Barnet (Trustee) [2017] FCAFC 60, Ms Low, the wife of a bankrupt and the bankrupt’s only creditor, funded the the bankruptcy trustee’s pursuit of two properties.  Upon sale of the properties, Ms Low was paid the entirety of the amount of her claims from the proceeds of the sale of one property, together with interest for the monies she had advanced to indemnify the Trustee.

The issue requiring determination in the administration of the bankrupt estate arose when Ms Low also sought to recover, in addition to her provable debt, a “risk premium” being the balance of the proceeds of the sale of the property which she regarded as “a just and equitable amount as a reward for the assistance (both personal and financial)” in funding the Trustee’s recovery efforts.

The Trustee refused to pay any “risk premium” to Ms Low, an approach approved by judge at first instance, however Ms Low appealed the decision to the Full Court of the Federal Court of Australia.

The Bankruptcy Act

The case hinged on the statutory construction of the provisions of the Bankruptcy Act (the Act). The Court noted that the general proposition and indeed to purpose of the Act operated such that:

“[18] …upon bankruptcy a bankrupt’s property is vested in his trustee so as to be made available for the payment of his provable debts and thereafter to enable a bankrupt to ‘start afresh’”

Against that background, the Court was asked to interpret the meaning of the phrase “over others” used in section 109(10) of the Act which states:

(10)  Where in any bankruptcy:

  • property has been recovered, realized or preserved under an indemnity for costs of litigation given by a creditor or creditors; or
  • expenses in relation to which a creditor has, or creditors have, indemnified a trustee have been recovered;

the Court may, upon the application of the trustee or a creditor, make such orders as it thinks just and equitable with respect to the distribution of that property and the amount of those expenses so recovered with a view to giving the indemnifying creditor or creditors, as the case may be, an advantage over others in consideration of the risk assumed by creditor or creditors (our emphasis added).

Decision

The central question before the Court was whether the phrase “over others” as employed in section 109(10) is confined to conferring an advantage “over other creditors” or whether that phrase should be construed as conferring an advantage “over all others, including the bankrupt” given Ms Low was the only creditor and any residual funds in the estate would be returned to the bankrupt upon discharge.

The primary judge looked to the legislative context of section 109(10), the authorities which have discussed the comparable section 564 of the Corporations Act 2001 (Cth) and the legislative objective sought to be achieved by section 109(10) in ultimately rejecting Ms Low’s Claim.

At trial, the primary judge had rejected Ms Low’s claim on the basis that the purpose of section 109(10) of the Act is to address the priority of payments to be made in the administration of a bankrupt estate and contemplates an indemnifying creditor getting an “advantage” to reward them for taking the recovery risk. Understood in this way, the priority is over other creditors who would otherwise rank equally in the distributions.

Ultimately on appeal to the Full Court of the Federal Court of Australia upheld the primary judge’s decision and refused Ms Low’s appeal on the basis that she had already been sufficiently rewarded by being paid the full amount of her proven debts plus interest and should not be able to make a profit out of the bankruptcy.

The decision of the Full Court may well have been different if there were other creditors involved in the Bankrupt’s estate however, as Ms Low was the only creditor of the Bankrupt’s estate, the Court opined at paragraph [66] – [67] that:

“To construe s 109(10) in such a manner as to permit Ms Low to recover much more than all of her provable debts, interest and payments made to the trustee to pursue litigation to recover the two Wellington Street properties, it is respectfully considered, would serve no legislative purpose to be discerned from the Bankruptcy Act itself and would serve only an impermissible purpose, namely the punishment of Mr Mathai [the Bankrupt].

Section 109(10) should not be construed so as to permit a creditor to recover the entirety of the balance of a bankrupt’s estate.  To so construe s 109(10) would neither be “just” nor would it be to confer an “advantage” upon Ms Low “in consideration of the risk assumed”.

Take home point

The case provides some guidance to creditors of a bankrupt estate who may be considering indemnifying a trustee with respect to a recovery claim. In particular, the case highlights the circumstances the Court will take into account when making orders with respect to the distribution of property which may give an indemnifying creditor an advantage over other creditors.

For more information contact ERA Legal.