The obligation of the insolvency practitioner to act honourably and fairly in the administration of insolvent estates

23 November 2015

In this issue:

Reviewing the nature and scope of the rule in Ex parte James requiring fairness in the administration of insolvent estates
The ethical standard of fairness contrasted with strict legalism
Cases illustrating the application of the rule in Ex parte James
Cases where the courts have declined to apply the rule in Ex parte James

Introduction

There is a fundamental principle arising in the administration of an insolvent estate that the insolvency administrator is obliged to demonstrate “right-mindedness” and “fairness” in the course of the insolvency process.

For example, on occasions the payment or transfer of property received by the liquidator of a company or trustee in bankruptcy has been made under a mistake, such that the party making the payment or transfer in error may seek to have the funds or property restored.

One option available to a claimant in these circumstances is to invoke the rule in Ex parte James. Under that rule the essential argument is that it is unreasonable and unfair for the insolvency administrator to take advantage of funds or property acquired in these circumstances, irrespective of the strict legal position.

At this stage it will be useful to consider the scope of the rule in Ex parte James. In doing so we shall observe that the rule in Ex parte James has the potential to permeate all aspects of insolvency administrations and is not confined to cases of alleged unfair enrichment.

The nature and scope of the rule in Ex parte James

Generally stated, the rule in Ex parte James requires that a liquidator or trustee in bankruptcy avoid invoking strict legal rights where this would result in outcomes contrary to ethical standards of commercial fairness. As the court in Star v Silvia (No1) (1994) 12 ACLC 600 at 604 observes:

“The principle should be applied to ensure that the liquidator does not hold property where there are claims of conscience against the property, without recognizing those claims of conscience.”

The following cases provide useful examples of the operation of the rule.

Application of the rule in Ex parte James in cases involving alleged unfair enrichment

Re Paddington Town Hall Centre Ltd (in liquidation) (1979) 41 FLR 239, SC (NSW)

At the date of winding up the company had accounts with its banker with credit balances totaling $8,218, and loan accounts with a debit balance of some $70,000. Following his appointment the liquidator requested the bank to transfer the credit balances to the liquidation account. The bank complied with this request and then submitted a proof of debt in the sum of the debit accounts. Subsequently when the bank became aware that it possessed a right of set off under the Corporations Act, the bank sought from the liquidator reimbursement of the sum of $8,218 in respect of which it claimed a set off, while reducing the $70,000 proof of debt by the amount recovered.

In the first instance the liquidator took the position that the bank was estopped from claiming back the $8,218. Subsequently these proceedings were commenced by the liquidator seeking directions from the court as to the appropriate disposition of the funds.

In applying the rule in Ex parte James the court reasoned that in view of the bank’s mistake as to its statutory right of set off, the liquidator was in substance possessed of funds belonging to someone else, and so ought to set an example by restoring the funds to the bank which could then proceed to give effect to its right of set off.

Barringtons Accounting Pty Ltd v Barringtons Your Business Advisors Pty Ltd (in liquidation) (2015) WASC 56, 11/2/2015

Recently the Supreme Court of Western Australia has had occasion to review the rule in Ex parte James.

In the above case the plaintiff had purchased a company’s business assets. Subsequently the company proceeded into liquidation. The essence of the plaintiff’s claim was that a number of its clients, who had previously been clients of the company, had mistakenly made payments in respect of services performed by the plaintiff into bank accounts in the name of the company in liquidation, intending that the payments be made to the plaintiff. The payments were made both before and after appointment of the liquidator in the amount of $268,646. The plaintiff sought leave of the court to commence proceedings against the company in liquidation with a view to recovery of the funds.

For reasons beyond the scope of this discussion the court determined that the applicant did not have standing to bring proceedings against the company that effectively involved the rights of the clients.

Importantly, however, the court identified an alternative to action against the company, namely, the supervisory role of the court with the principles of the rule in Ex parte James in mind. In canvassing the relevance of the rule in Ex parte James, the court concluded:

“In my view it is at least arguable that, on it being discovered that money has been mistakenly paid to a company in liquidation under the control of a liquidator appointed by the court, the court would act in the manner contemplated by the earlier authorities [applying the rule in Ex parte James] and direct that the money be repaid. As the principle is concerned with practical justice rather than legal entitlement, it is at least arguable that the court might make a direction for repayment without demanding an expensive and time consuming inquiry….”

Clearly the court envisaged that the most appropriate means of resolving the matter was an application to the court with a view to invoking the rule in Ex parte James.

Does the rule in Ex parte James extend beyond cases involving recovery of mistaken payments?

The line of cases involving the rule in Ex parte James has moved beyond mistaken payments, with potential to regulate a range of events arising out of the administration of insolvent estates.

For example, in Re Associated Dominions Assurance Society Pty Ltd (1962) 109 CLR 516, an employee of a company in liquidation had a two year limitation period to bring a claim for payment in lieu of long service leave. The employee had relied upon the liquidator’s announced intention to seek directions from the court on the matter, and accordingly did not make an application in the ordinary way. When the liquidator eventually made the application for directions the two years had elapsed since the termination of employment, so as to prevent the employee from pursuing the claim in the winding up irrespective of the outcome of the directions application. The High Court held:

“In those circumstances I do not think it would be proper to allow the claim to be defeated by the limitation…. And upon the principles enunciated in Ex parte James …. I propose to disregard the suggested limitation.” (para 5).

Cases where the rule in Ex parte James has not been applied

On occasions the courts have been reluctant to apply the rule in Ex parte James, particularly if it can be shown that the insolvency practitioner has not personally been involved in the transaction or decision under scrutiny.

For example, in Re Alias Ayoub Ex parte: Brian Raymond Silvia (1983) FCA 112, unbeknown to the trustee in bankruptcy the undischarged bankrupt commenced operating a business. In the course of trading the bankrupt purchased stock and office equipment on credit. The creditors were unaware of the bankruptcy when they extended credit to the bankrupt. Although the stock and equipment supplied became after-acquired property vesting in the trustee for the benefit of pre-bankruptcy creditors, the suppliers’ claims arising after the date of bankruptcy were not provable in the bankruptcy.

As a consequence the trustee sought directions from the court as to whether the rule in Ex parte James justified the trustee paying these debts out of the assets available in the bankruptcy. In deciding that the case “does not amount to inequitable conduct of the kind that has hitherto been regarded as sufficient to invoke the rule in James’ case,” the court was influenced by the fact that:

There was no evidence as to what steps, if any, the creditors took to check the bankrupt’s credit worthiness before supplying him with goods
The creditors ran the risk of doing business with the bankrupt
The trustee was unaware of the transactions
It was not to the point that remedies available to the creditors to recover their debts against the bankrupt personally were likely to prove fruitless.

Summing up

It is apparent that the enquiry undertaken by a court in applying the rule in Ex parte James will often be fraught with vagaries and uncertainty. Each case must be dealt with on its own facts and the court is free to act according to the judge’s opinion as to what would be just and fair in each case.

Moreover the enquiry undertaken by the courts is not simply to determine if a legal right exists in the hands of the claimant. An enquiry premised on “fairness” extends beyond this into the realm of ethical propriety and commercial morality. As one court observes:

“When the authorities employ the phrase “just and fair” they are not using it in the sense of unconscionable as a matter of the settled principles of equity, but rather, just and fair in the mind of the person on the Bondi bus.”

Notwithstanding the vagaries involved and the likelihood of questions raised becoming “the subject of honest difference among honest men,” the courts have not been deterred in their willingness to apply the rule in Ex parte James to ensure that the highest standards of fairness are achieved in the administration of insolvent estates.