Unwise parental support of a child's failing business
Following on from last months newsletter, a more technical response.
When it was apparent Janice Townsend (nee Grima), sole director of NQ Blinds & Shutters Pty Ltd was in financial difficulty, her parents Ronald and Violet Grima decided to try to help their daughter.
Accordingly, Ms Townsend granted them a mortgage on interests she held in two properties and her parents believed it would protect them in the event of non-payment and/or collapse of NQ Blinds & Shutter Pty Ltd.
Under this arrangement the parents would advance their daughter money to the value of her interests in the properties.
However, Ms Townsend was eventually bankrupted for an unsatisfied judgement debt and Peter Macks was appointed Trustee of her bankrupt estate.
In an attempt to save considerable angst and money for all parties concerned, he held numerous discussions with the Grima family on obvious legal issues relative to the mortgage. When his advice was ignored, he had no alternative but to apply to the Federal Circuit Court of Australia to order the mortgage void against him pursuant to provisions of section 120 of the Bankruptcy Act 1966 (Cth) “the Act”.
The Trustee’s position
Mr Macks’ argued the mortgage was null and void and completely without legal force or binding effect. This was because it was an untimely under the Act, and also because Mrs Townsend gave no proper consideration for the transfer to her parents of her interests in the family properties concerned, the basis of the mortgage.
He therefore asked to have the transaction set aside as a consequence of section 19(1)(e) & (f) of the Act. In this regard, the Trustee relied on section 120(1) of the Act, which states:
(1) A transfer of property by a person who later becomes a bankrupt (the transferor) to another person (the transferee) is void against the Trustee in the transferor’s bankruptcy if:
(a) the transfer took place in the period beginning 5 years before the commencement of the bankruptcy and ending on the date of the bankruptcy; and
(b) the transferee gave no consideration for the transfer or gave consideration for the transfer or gave consideration of less value than the market value of the property.
In applying to the Court to order the mortgage void against him, Mr Macks named Ronald Grima and Violet Grima as respondents to his application.
The respondents’ position
They opposed the application on the basis that their daughter, Ms Townsend, was solvent at the time she mortgaged her interests in the two properties.
Nevertheless, the Court heard the Grima’s own solicitor had obtained a valuation of the properties that showed Ms Townsend’s sixth interest in each of them (together totalling $150,000) was in fact $16,500 less than the value of the mortgage she’d granted in favour of her parents.
Ms Townsend’s position was that the mortgage granted to her parents was to secure advances made by them to her between 17 January 2008 and 17 July 2012, and she asserted that as of 20 November 2012 she was personally solvent.
She said she’d been able to service a mortgage on her house up to that time, and that subsequently, apart from the mortgage held by her parents, she had no significant debts.
Her accountant told the Court that NQ Blinds & Shutters Pty Ltd ceased trading in November 2012 and the import of his evidence was that he believed Ms Townsend was then solvent.
It was shortly thereafter she executed the mortgage in favour of her parents (repayable on demand and interest free) the validity of which Mr Macks was challenging.
The Court heard evidence that monies her company had borrowed by way of a credit contract from the Queensland Country Credit Union was in effect Ms Townsend’s only bank account from which she had been withdrawing $1000 a week as wages. In June 2013, she failed to remedy a default in required payments under that contract
The Court’s view
This, according to the Federal Court’s Judge Brown, “led to her bankruptcy”.
Indeed, Ms Townsend’s mother Mrs Grima told the Court when NQ Blinds & Shutters Pty Ltd stopped trading she and her husband feared their daughter would not be able to repay $60,000 they’d advanced her since 2008 to help keep her in business, and this was why they’d arranged the mortgage.
However, Judge Brown decided:
- It was self-apparent there was no written loan agreement.
- Mr and Mrs Grima must be regarded as having been unsecured creditors, at least when the monies were advanced.
- It was clear despite the accountant’s evidence, Mr and Mrs Grima’s belief and their daughter’s insistence, NQ Blinds & Shutters Pty Ltd was not solvent when it ceased to trade, otherwise the Credit Union would not have had recourse to Ms Townsend’s guarantee that would likely engage her real property.
- The intended effect of the mortgage was to put Mr and Mrs Grima in a position of advantage over other potential unsecured creditors of either Ms Townsend or her company or both.
- There was no evidence Ms Townsend ever personally received any advances from her parents, rather payments were made to her company to repay its creditors.
Judge Brown said it was in these circumstances that Mr Macks as Trustee of Ms Townsend’s bankrupt estate was asking the court to conclude that no consideration could have been or was given by the bankrupt for the mortgage in question, granted after her company had ceased to trade. (See earlier explanation of required “consideration” under the Act.)
His Honour said he also noted Mr Macks’ alternative request that even should the Court find money was advanced to Ms Townsend personally, there could be no proper consideration for the mortgage under the Act. This was because any consideration must be considered to be “past consideration” given dates in the mortgage schedule relative to when it was executed in November 2012.
Vital aspects of “proper consideration”
Mr and Mrs Grima claimed that an undertaking they’d given their daughter to forebear from suing her for money advanced prior to granting the mortgage, was “a proper consideration” that had value in terms of legal costs that could arise from a decision to sue. They asserted they were in fact in a position to sue Ms Townsend for their money in November 2012 but had elected no to do so in return for the grant of the mortgage in question.
However, Judge Brown’s view was that Mr and Mrs Grima didn’t require a mortgage until after their daughter’s business ceased to trade. In any event, money they provided between 2008 and 2012 must be regarded as “past rather than proper consideration” for the mortgage granted in November 2012, which was in effect “a retrospective device”.
On the advice of their lawyer the parents were relying on Austin J’s finding in Sutherland v Brian in which His Honour accepted that “forebearance to sue” had always been regarded in law as good consideration.
But Judge Brown said this would also always depend on circumstances in individual cases, and that the concept of consideration was derived primarily from commercial considerations. In the case before him there was a paucity of evidence regarding the commercial nature of the relationship between Mr and Mrs Grima on the one hand and Ms Townsend, and NQ Blinds & Shutters Pty Ltd on the other. His Honour said that in his view the relationship was as one.
“In a commercial setting, there is a vast distinction between dealing with a proprietary limited company and an individual. Commercial entities need to know whom they will be able to sue and what will be the prospect of successfully suing.”
His Honour pointed out that one of the intentions of section 120 of the Act was to prevent a bankrupt’s creditors being potentially prejudiced by improper transactions having the consequence of transferring property away from the control of the bankrupt without the bankrupt being properly compensated.
In this case the mortgage granted to Mr and Mrs Grima was designed to have such a consequence, which, were it to be ruled valid, would unfairly prevent creditors securing recompense for their proven debts.
Judge Brown said the parents had simply “hoped for the best” in devising transactions lacking both commercial reality and appreciation of provisions of the Act.
Orders of the Court
(1) A declaration be made that the transfer of property made under the mortgage dated 22 November 2012 granted by Janice Townsend to the respondents Ronald Grima and Violet Grima is void against the applicant Peter Ivan Macks.
(2) The respondents pay the applicant’s costs of the application to be agreed or failing agreement as taxed.