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Can the Court make a post-bankruptcy costs order apply retrospectively?

"A day wasted on others is not wasted on one's self" - or is it? In one of the first decisions this year, the Federal Circuit Court of Australia reconsidered the position regarding costs orders made after the date of bankruptcy.

In ACN 116 746 859 Pty Ltd (formerly Palermo Seafoods Pty Ltd ACN 116 746 859) v Menniti [2020] FCCA 24 Judge Jarrett had to decide whether a Court has the power to effectively order a trustee to accept, as a debt in the bankruptcy, a costs order against the bankrupt made after a sequestration order.

 The Facts

In an interesting turn of events, this matter involves two creditor's petitions on foot at the same time. This should not occur as petitioning creditors are required to search for existing petitions, prior to filing their own. Nevertheless, in unusual circumstances it does sometimes happen. Here, the first creditor’s petition against the debtor, by Mr Murphy (“the Murphy petition”) was unable to proceed because the judgment debt on which the Murphy petition was based had become the subject of an appeal. ACN 116 746 859 Pty Ltd (“Palermo”) filed an appearance (and an affidavit of debt) as a supporting creditor and applied to be substituted as the petitioning creditor in the Murphy petition. However, a substituted creditor proceeds on the basis of the existing petition, and so the Court refused Palermo’s application for the same reason that Mr Murphy was unable to proceed i.e. that the Murphy judgment debt was subject to an appeal.

Palermo had at an earlier stage issued its own bankruptcy notice to the debtor. An application to set aside the Palermo bankruptcy notice was dismissed and Palermo then filed a separate creditor's petition. Unbeknownst to Palermo at the time, the debtor had filed (but did not serve) an application to review the Registrar's decision to dismiss the application to set aside the Palermo bankruptcy notice.

Before the second (Palermo’s) creditor's petition was heard, the appeal of the first petitioning creditor's debt was dismissed and both creditors’ petitions came before the Court on the same date. The first petition was heard first and a sequestration order was made.

The debtor sought a stay of the sequestration order and filed an application to review the Registrar's decision to make the sequestration order. Palermo’s creditor’s petition was adjourned until the same date as the application for review of the Registrar's decision of the sequestration order.

The day after the sequestration was made, the Court upheld the debtor’s application regarding the Palermo bankruptcy notice and set Palermo’s notice aside. This meant there was no foundation (in terms of an act of bankruptcy) for the Palermo creditor’s petition. Thinking quickly, Palermo sought to amend its petition to rely upon the same act of bankruptcy as in the first petition – the one which had already been determined and in which a sequestration order had already been made!

Why did they bother? It may have been because there was the possibility of a review of the sequestration order being successful (although if so, it is unclear how the Palermo creditor’s petition could have succeeded based on the same act of bankruptcy) but otherwise appears to have been to do with Palermo’s costs.

When the matter came back before the Court, the first petitioning creditor, the debtor, and the trustee had reached an agreement to dismiss the application to review the sequestration order.

This meant that Palermo’s creditors petition should be dismissed. But what to do with Palermo’s costs of its petition? Palermo and the debtor reached an agreement that Palermo’s costs be taxed and paid from the debtor’s estate subject to the Court’s power to make such an order. However, the trustee in bankruptcy appeared and brought the Court’s attention to the decision in Foots v Southern Cross Mine Management Pty Ltd [2007] HCA 56 and suggested that such an order might be inappropriate.

The decision in Foots

In Foots, the High Court held that a costs order made against a debtor is provable in a debtor’s bankruptcy only if the order is made before the date of the bankruptcy. If the costs order is made after the date of bankruptcy then it is not provable.

In arriving at its decision, the High Court considered section 82 of the Bankruptcy Act 1966. Section 82 sets out what debts are and are not provable in a debtor’s bankruptcy; and specifically provides that the only debts which are provable are those which arise from an obligation incurred before the date of bankruptcy.

It is often thought that because the proceedings were commenced before bankruptcy, that therefore the creditor’s costs incurred in respect of those proceedings should be provable in the bankruptcy. However the High Court held that since the making of a costs order is at the discretion of the Court, unless and until the Court has made an order for costs, at most there is a “possibility or a risk that an order for costs may be made” (at [36]. This is not enough to found a provable debt.   

Therefore in the absence of a costs order for the payment of a creditor’s costs, normally (and subject to some exceptions such as contractual entitlements to costs, etc) a claim for costs is not provable in bankruptcy.

The outcome

Palermo accepted that if a costs order was made in their favour against the debtor, Foots precluded the costs order from being a provable debt in the bankruptcy. However, Palermo sought to circumvent Foots by seeking that the costs order be made with retrospective operation to the date of bankruptcy pursuant to the broad discretion of the Court under section 79 of the Federal Circuit Court of Australia Act 1999 and section 32 of the Bankruptcy Act 1966.

Palermo argued that Foots did not consider retrospective orders but left such matters to the discretion of lower courts as appropriate, and the Court could therefore make such a retrospective costs order.

Judge Jarrett rejected Palermo’s argument. It did not grapple with the underlying proposition of Foots; that an obligation which arises after the date of bankruptcy is not provable in the bankruptcy and the obligation to pay costs does not arise until the making of the costs order.

His Honour indicated that even if the Court could make an order of the kind sought by Palermo, it would not be competent for Palermo to seek the order in the present circumstances. This is because such a step would be seen as enforcing a remedy (ie the claim for costs) in respect of a provable debt (ie Palermo’s underlying debt claim against the bankrupt) which is prohibited under section 58(3) without leave of the Court (no such leave having been sought or granted in the present case).

Ultimately, the Court was not satisfied that it should make a retrospective costs order and therefore ordered that the bankrupt debtor pay Palermo’s costs rather than it being paid from the bankrupt estate. This essentially left Palermo with a non-provable costs order against an impecunious bankrupt debtor, all of whose assets had vested in the trustee.

In order to participate in the distribution of any assets as a creditor, it would be necessary for Palermo to enforce its costs order against the bankrupt, commence further bankruptcy proceedings and make the bankrupt bankrupt a second time, for no obvious useful benefit.

The takeaway

This case highlights the importance of obtaining specialist advice before filing a creditor’s petition or risk expending funds on proceedings without merit, which will not be able to be recovered.

Ellen Ferris

Solicitor
Matthews Folbigg

T: 02 9806 7456

E: EllenF@matthewsfolbigg.com.au

 

Stephen Mullette

Principal

Matthews Follbigg
T: 02 806 7459

E: stephenm@matthewsfolbigg.com.au