Vesting of trust property in a trustee in bankruptcy and reasonable belief: some guidance for trustees in bankruptcy
On 13 December 2019, in Boensch v Pascoe  HCA 49, the High Court dismissed an appeal from the Full Federal Court by a former bankrupt seeking to establish that a caveat lodged over real property by his prior trustee in bankruptcy was done without reasonable cause, entitling him to compensation pursuant to section 74P of the Real Property Act 1900 (NSW) (RPA).
In coming to this decision, the High Court considered the operation of section 58(1) of the Bankruptcy Act 1966 (Cth) (BA), which, upon the making of a sequestration order, provides that property of a bankrupt vests in his or her trustee in bankruptcy, and the exclusions to the general principle that property is generally divisible amongst the bankrupt’s creditors, including section 116(2)(a) of the BA, which excludes trust property held by a bankrupt from vesting in a trustee in bankruptcy.
The former bankrupt, Mr Boensch set up a trust (the Trust) of which he was the trustee, and which identified real property located at Rydalmere NSW (Rydalmere property) as trust property, held beneficially on behalf of his children.
Following the making of a sequestration order against Mr Boensch by the Federal Magistrate Court, Mr Pascoe was appointed as his trustee in bankruptcy. Mr Pascoe immediately lodged a caveat on the Rydalmere property, claiming a “Legal Interest pursuant to the Bankruptcy Act”. In the course of administering the bankruptcy, Mr Pascoe came to the view that the Trust was a sham to defeat creditors and that he had a right to be indemnified by the trust for certain expenses he had incurred on behalf of the Trust as its trustee, although the value of that right of indemnity was uncertain.
Mr Pascoe’s view that the Trust was a sham was based on legal advice; however, that view was not upheld in subsequent litigation in the Federal Magistrates Court, on appeal or in a special leave application to the High Court, following which Mr Pascoe allowed the caveat to lapse.
Following his later discharge from bankruptcy, Mr Boensch commenced Supreme Court of NSW proceedings against Mr Pascoe seeking statutory compensation pursuant to section 74P of the RPA, on grounds that Mr Pascoe had lodged the caveat without reasonable cause.
First instance decision
The proceedings were listed for hearing for the separate determination of that question. At first instance, his Honour, Darke J found in favour of Mr Pascoe.
Mr Boesch appealed, initially to the NSW Court of Appeal, which dismissed the appeal on the basis that it did not have jurisdiction to deal with the bankruptcy issues. Mr Boesch then appealed to the Full Court of the Federal Court, which, on 18 December 2018, dismissed the appeal.
On 21 June 2019, the High Court granted Mr Boensch special leave to appeal.
High Court Decision
In coming to its decision as to whether Mr Pascoe had lodged the caveat without reasonable cause, the High Court considered:
- A threshold issue, being whether the applicable common law authorities were inconsistent with the interpretation of sections 58(1)(a), 115, 116(1) and 116(2) of the BA, so to determine whether property held on trust by a bankrupt trustee can vest in a trustee in bankruptcy (the vesting question).
- The appropriate test for establishing whether a caveator had reasonable cause to lodge a caveat (the Beca Developments test) within the context of a claim for compensation pursuant to section 74P of the RPA (the reasonable cause test).
- The permissible grounds for lodging a caveat (the caveat issue).
The vesting question
Mr Boensch did not persuade the Court that the authorities on the vesting question were “plainly wrong”. The Court confirmed that property held on trust by a bankrupt trustee can vest in a trustee in bankruptcy in accordance with section 58(1) of the BA, provided that the bankrupt has some beneficial interest in it, either vested or contingent.
The High Court accepted the existence of Mr Boensch’s right to be indemnified by the Trust for various payments he had made in his capacity as trustee, such as rates, mortgage payments and utilities. It did not matter that Mr Pascoe did not have actual knowledge of this right of indemnity at the time he lodged the caveat. Nor did it matter that the right of indemnity may have been of little value. It was the existence of this beneficial interest, rather than its value, that triggered the exception to the exclusion found in s 116(2). Property held on trust by a bankrupt can vest in a trustee in bankruptcy, provided that the bankrupt has some interest in the property, either vested or contingent and no matter how remote. As Mr Boensch had a beneficial interest in the trust property, Mr Pascoe had reasonable cause to lodge the caveat.
The reasonable cause test
The High Court rejected Mr Boensch’s submission that the test under section 74P of the RPA should be a purely objective one, and that the caveator’s subjective belief was irrelevant. The Court confirmed the test set out in Beca Developments that a claimant under s74P must establish that the caveator did not have either a caveatable interest or an honest belief based on reasonable grounds that the caveator had a caveatable interest.
The High Court held that:
- if a trustee in bankruptcy has reasonable grounds to conclude that a bankrupt trustee has an extant beneficial interest in property held on trust for another, the trustee will be justified in lodging a caveat, provided that he/she does so with an honest belief on reasonable grounds;
- a technical deficiency in the description of the interest claimed in the caveat will not, on its own mean that the caveat was lodged without a “reasonable cause”; and
- a caveat can only be lodged if the caveator has a legal or equitable interest. A statutory right, such as those conferred by sections 120 and 121 of the BA to set aside a transfer of land, does not constitute either a legal or equitable interest in land.
The High Court has provided practical guidance for trustees in bankruptcy as to when to lodge a caveat on property held by a bankrupt on trust. The decision provides some reassurance as to the lodgement of a caveat at an early stage of administering a bankrupt estate when the trustee may have only very limited information and is supportive of a proactive approach by trustees in bankruptcy to protect the interests of creditors.
Gilchrist Connell acted for Mr Pascoe.