Finance & Markets Update - Summer Edition

Update on Short Selling Ban and Legislation

Summary

Following the Corporations Amendment (Short Selling) Act 2008 (Cth) (Amending Act) receiving Royal Assent on 11 December 2008, ASIC announced that certain exemptions to the ban on naked short selling would continue to apply effective from an unspecified date. Further, on 21 January 2009, ASIC extended the current ban on covered short selling of financial securities to 6 March 2009.

Background

On 22 September 2008, ASIC implemented a ban on, among other things, naked short selling of all securities and covered short selling of securities on the S&P/ASX 200 Financials and securities issued by Wesfarmers Limited, The Rock Building Society Limited, Wide Bay Australia Limited, Futuris Corporation Limited and Calliden Group Limited (Financial Securities).

On 11 December 2008, the Amending Act received Royal Assent. The provisions of the Amending Act come into force in 3 stages as set out below.

11 December 2008                                                                                 

Schedule 1 to the Amending Act amends section 1020F of the Corporations Act 2001 (Cth) (Act) to remove any doubt in relation to ASIC’s power to take action regarding short selling. Schedule 1 also ratifies the various class orders recently made by ASIC in relation to short selling activity.

8 January 2009

Schedule 2 to the Amending Act repeals sections 1020B(4), (5) and (6) of the Act. Effectively, the provisions of Schedule 2 provide that naked short selling will only be permitted where the seller has, at the time of sale, entered into a contract to purchase the relevant securities conditional only on payment of consideration, receipt of a proper instrument of transfer or receipt of title documents.

Section 1020C of the Act which was also repealed pursuant to Schedule 2 to the Amending Act, granted ASIC the power to prohibit short selling. However, ASIC is still able to grant exemptions from, and modify the short selling provisions in the Act, by virtue of section 1020F of the Act.

Not yet in force  

Naked short selling

Further to the Amending Act, ASIC announced that certain exemptions to the ban on naked short selling which are currently available in the Corporations Regulations 2001 (Cth) (Regulations) will come into effect once several of the Regulations have been repealed.

The exemptions are set out in ASIC Class Order 09/1051 and relate to:

• giving or writing of certain exchange traded call options;
• unobtained financial products; and
• certain corporate bonds, debentures and government bonds.
   

Extension of ban on covered short selling of Financial Securities

Contrary to its advice on 13 November 2008 that the ban on covered short selling of Financial Securities would expire on 27 January 2009, ASIC announced on 21 January 2009 that the ban would be extended to 6 March 2009.

ASIC stated in its media release dated 21 January 2009 that the main reason for the extension of the ban was the increased volatility in financial and banking stocks overseas. The media release also indicated that if ASIC becomes satisfied that this volatility was not primarily caused by the resumption of short selling in the relevant countries, it may lift the ban earlier than 6 March 2009.

Geoff Cairns, Partner, Michael Hodgson, Partner, Crystal Png, Lawyer

Commissioner of Taxation v Bruton Holdings Pty Ltd (in liq) [2008] FCAFC 184

Section 260-5 of Schedule 1 to the Taxation Administration Act 1953 (Cth) (the Tax Act) enables the Commissioner of Taxation (Commissioner) to issue a notice (Garnishee Notice) to a debtor of a company, requiring that debtor to pay a debt, not to the company, but directly to the Commissioner.

Historically, it has been used by the Commissioner in non-insolvency situations. Recently, the Federal Court and Full Court of the Federal Court have considered whether or not a Garnishee Notice, served on a debtor, after the commencement of a creditors’ voluntary liquidation, was valid and effective.

In the matter of Bruton Holdings Pty Limited (In Liquidation) v Commissioner of Taxation [2007] FCA 643, the  Commissioner had issued a Garnishee Notice to solicitors for a taxpayer, in relation to a $7.7 million tax debt of the taxpayer. The solicitors held over $400,000 in trust for the taxpayer ‘on account of costs and disbursements’.

The liquidators argued that the Garnishee Notice was invalid pursuant to s.500(1) of the Corporations Act 2001 (Cth) (the Corps Act) as it was an ‘attachment ... put in force against the property of the company after the passing of the resolution for voluntary winding up’. Justice Allsop agreed with the liquidators and held that the Garnishee Notice was void. His Honour also held that “the operation of s.260-5 was inconsistent with the system of priorities prescribed by the relevant provisions of the Corporations Act”.

Accordingly, the solicitors for the taxpayer were not required to comply with the Garnishee Notice issued by the Commissioner under s 260-5 of the Tax Act.

The Commissioner appealed the decision.

In a judgment delivered on 1 December 2008, the Full Court of the Federal Court ([2008] FCAFC 184), allowed the appeal by the Commissioner and held that “the process prescribed by s.260-5” is not an attachment for the purposes of s.500 of the Act.

This finding relied upon a previous decision of the Full Federal Court in the case of Commissioner of Taxation v Donnelly 1989 25 FCR 432. In that decision, the Court concluded that a s.218 Notice under the 1936 Bankruptcy Act, which was a similar process to the s.260-5 notice in the present case, was not an “attachment” for the purposes of section 118(1) of the Bankruptcy Act (this section had similar provisions to the Corporations Act s.500).

Within Donnelly, the Court was asked to determine whether the word “attachment” included only methods of recovery involving court process (“curial process”) or whether it included other, non-curial processes. Their Honours accepted that the term “attachment” might be used in either sense, however, the authorities cited in that case suggested that the narrower usage (limited to curial process) was more common than the wider. Their Honours in Donnelly concluded that, in the context of the Bankruptcy Act, the term should be given the narrower meaning. That decision was, at least in part, based upon the reference in s 118(1)(b)Bankruptcy Act to the “taxed costs of the ... attachment”, suggesting a curial context. 

In Bruton the Full Federal Court followed that decision and found that the s.260-5 process was not an attachment, as it was not a curial process.

The decision of the Full Court of the Federal Court has some serious implications. It confirms that the Commissioner can issue a Garnishee Notice directly to a third-party debtor, after the appointment of a liquidator in a creditors’ voluntary liquidation. Instead of the company’s debtors paying money to the liquidator which would then be distributed to creditors, they can now be forced to pay the money directly to the Commissioner to offset any tax liability the failed company might have.

The Commissioner, therefore, has not only regained his priority status as a creditor ranking ahead of other unsecured creditors, but can now elevate his priority as a creditor above a liquidator’s claim for his or her costs and expenses.

The liquidators of Bruton Holdings Pty Limited are currently considering making an application to the High Court for special leave to appeal the case. The Full Court has opened the door on a possible appeal by saying:

“In our view, the relevant question is whether a notice given pursuant to s 260-5, after the commencement of the winding up, affects the operation of s 501. That question has not been argued, and so we refrain from expressing a concluded view. However it is at least arguable that the statutory mandate imposed by s 501 overrides any later charge created by a s 260-5 notice. If so, then s 260-5 is not inconsistent with the structure of the Corporations Act”.

Katie McCaul, Lawyer

Recent Decisions Regarding Fraud and “all moneys” Mortgages

Introduction

Two recent decisions of the NSW Supreme Court have followed the line of reasoning in cases such as Perpetual Trustees Victoria Ltd v Tsai [2004] NSWSC 745 (Tsai) by confirming that registration of a mortgage confers indefeasibility of title on the mortgagee even though the mortgage in question has been forged. These decisions differ however in that, unlike Tsai, they involve more than one borrower.

Following Tsai

Following Tsai, a number of decisions in NSW confirmed the position that indefeasibility of a registered mortgage does not extend to a separate loan not expressly incorporated in the mortgage. These decisions include: Chandra v Perpetual Trustees Victoria Ltd [2007] NSWSC694 (Chandra), Yazgi v Permanent Custodians Ltd [2007] NSWCA 240 (Yazgi), Perpetual Limited v Costa [2007] NSWSC 1093, Vella v Permanent Mortgages Pty Ltd [2008] NSWSC 505, Provident Capital Ltd  v Printy [2008] NSWCA 131 (Printy) and Perpetual Trustees Australia Ltd v Richards [2008] NSWSC 658.

All these decisions revolved around single defrauded borrowers. The recent decisions of Perpetual Trustees Victoria Ltd v Cipri [2008] NSWSC 1128 (Cipri) and Permanent Custodians Ltd v El Ali [2008] NSWSC 1264 (Ali) were different in that there was more than one borrower involved and only one of the borrowers’ signatures was forged on the loan and mortgage documents.

The decisions in Cipri and Ali

In Cipri, Perpetual Trustees Victoria Ltd (Perpetual) was the registered mortgagee of a property at Greystanes, owned by the first and second defendants as joint tenants. Perpetual was seeking possession of the land and an order that the second defendant repay what was outstanding under the loan. The second defendant (Mrs Cipri) signed a mortgage and loan agreement in favour of Perpetual and forged the signature of her husband (the first defendant) on both documents.

While the signature of Mr Cipri may have been forged, the signature of Mrs Cipri was her own. Both the mortgage and the loan agreement were drafted in such a way that each mortgagor’s obligation to pay the “Secured Money” under the loan agreement was joint and several. The mortgage, by reason of the definition of “Secured Money”, therefore operated in such a way as to secure the obligation of Mrs Cipri to pay all amounts owing under the loan agreement and did so by reference to the interests in the property of both Mr and Mrs Cipri.

At [58] Justice Hall differentiated those cases involving forged mortgages and a single borrower with the facts in the present case. In the case of a forged mortgage and a single borrower, because the agreement is void and no obligations arise under it, the mortgage does not secure the performance of any obligations under the loan agreement.

In the present case, on the other hand, there was a valid agreement between Perpetual and Mrs Cipri.

His Honour then discussed the principles as laid down in decisions such as Tsai, Chandra and Yazgi. His Honour differentiated between the mortgage as a debt on the land, which creates an estate or interet in land when registered even though it may have been forged, and the personal covenant to pay (that is the contractual obligation to pay the debt in the loan agreement), which does not create an interest in the land, and therefore cannot be enforced against a defrauded borrower.

At [77] his Honour looked at the decision of the Court of Appeal in Printy, where it was held that where a covenant in the mortgage requires payment in accordance with a separate loan agreement, provided moneys are in fact owing under the separate loan agreement, then the mortgagee is entitled to exercise its power of sale by virtue of a default in the observance of that covenant.

His Honour concluded that by reason of the definition of “Secured Money” in the mortgage, the mortgage secured Mrs Cipri’s indebtedness under the loan, as she was jointly and severally liable to pay the whole amount owing under the loan agreement. Given that the mortgage secured Mrs Cipri’s indebtedness and the whole property was subject to the mortgage, Perpetual was entitled to enforce the mortgage as against both Mr and Mrs Cipri’s interests in the property.

Mrs Cipri was also ordered to pay Perpetual the total amount outstanding under the loan as well as fees, charges, expenses and interest in accordance with the loan agreement. The defences of personal equity and the Contracts Review Act raised by Mr Cipri were unsuccessful.

In Ali, Ms Awad, the second defendant in the substantive proceedings, applied to set aside part of a default judgement. Judgement was given to Permanent Custodians Ltd (Permanent) for possession of land subject to a mortgage in its favour. The same judgement also ordered Ms Awad to pay an additional amount to Permanent. Ms Awad, in applying to set aside part of the default judgement, did not dispute the order giving Permanent Custodians possession of the property, rather she disputed that she owed a monetary amount to Permanent. This was because she alleged that she did not sign the mortgage and loan documents and that her signature was forged by Mr El Ali (the first defendant and the other party to the loan agreement and mortgage).

Ms Awad and Mr El Ali were joint owners of a property in Katoomba. Mr El Ali arranged a loan with Permanent Custodians for $150,000 secured by a registered mortgage over the Katoomba property. In doing so he forged the signature of Ms Awad who received no benefit from the moneys advanced.

Justice Rothman held that in the case of a registered mortgage, the doctrine of indefeasibility of title renders the interest, identified by the mortgage, valid and enforceable, notwithstanding any invalidity in the mortgage instrument itself.

Conclusions

The decisions of Cipri and Ali follow on from previous judgements relating to registration of forged mortgages by highlighting the fact that registration of a forged mortgage will confer an indefeasible title upon the mortgagee, which will allow the mortgagee to exercise its statutory rights as against the defrauded borrower if there has been a default under the loan agreement. The liability to repay the debt, however, is a personal covenant, and as such a mortgagee may not be able to recover outstanding loan moneys from a defrauded borrower. If the liability under the loan is joint and several the mortgagee can claim any moneys outstanding from the borrower who did sign the loan and mortgage documents.While these decisions may be viewed as a partial victory for mortgagees, they are not meant to be a substitute for due diligence. The one important lesson to come from the recent spate of cases regarding fraud and all moneys mortgages is that the most fundamental protection that a Lender has is to know their Customer.

Maria Andreou, Lawyer

Stern Warning on Recovery Of Indemnity Costs

Bowman Irani P/L (ACN 006 569 044) v St George Bank Ltd (ACN 055 513 070) [2008] VSCA 246

In evidence served by the Bank for the costs hearing, it became apparent that the Bank had a costs agreement with its solicitors that entitled it to a rebate of fees from its solicitors, on a sliding scale, based on the total annual fees billed for all matters.  The rebates received by the Bank were substantial.

The guarantors submitted that an allowance should be made when calculating the Bank’s costs, for the annual volume rebate of fees that the Bank’s solicitors had repaid in accordance with the costs agreement. The Bank argued that the rebate was referrable to the total fees paid by the Bank to the firm in any given year, and, as such, was not referrable to a particular matter or customer.  It also argued that the rebate was in essence a payment made by the solicitors to the Bank to secure the benefit of being on the Bank’s panel. The trial judge found against the Bank and held that the Bank was required to credit the volume rebates that it received. There was no appeal against this decision.

The matter was referred to a Master for calculation of the Bank’s costs. In that calculation, the Master included substantial credits exceeding $80,000, to reflect the appropriate portion of the rebate the Bank received, referrable to the legal costs that the Bank debited to Pinnacle’s account. 

The guarantors appealed, which appeal included an argument that related to the trial judge’s findings. They said that the Bank intended to rely on the combined effect of the cost agreement and relevant clauses of the facility and security agreements to “exact payment from its customers and guarantors of legal costs which, after the rebates were taken into account, exceeded the costs which the bank had incurred” and that the trial judge was in error in finding that this arrangement did not concern third parties (which was a point taken by the guarantors during the trial). 

The Appeal Court agreed that the trial judge was in error in finding that the arrangement did not affect third parties. The Court of Appeal also agreed that the arrangement itself constituted the wrongful exaction of excessive costs, however, the appeal failed because there was no wrongful exaction in this case as the trial judge had found that the indemnifying parties were entitled to a credit for the rebates that were payable under the arrangements (and that had been taken into account when the Master did the calculations). 

Whilst the appeal failed in this instance, in relation to the Bank’s practice Acting Appeal Justice Hargrave opined:

• Whether the Bank thought it was acting honestly or not is irrelevant.  The conduct of the Bank in keeping the rebate for itself was “wrongful and unjust”.  
• If the guarantors had paid all of the legal costs that were demanded from them, they would have an action against the Bank for unjust enrichment. 
• Recovery of all the legal costs claimed by the Bank would be against public policy because it would include the wrongful exaction of excessive costs.
• In his opinion, the Bank and all other banks and financiers with similar arrangements should ensure that their customers, guarantors and third parties who are liable to indemnify their legal costs, are given appropriate credits immediately upon receipt of any volume rebate or discount.  
  

Given what His Honour saw as the likelihood of this practice being widespread throughout the banking and financial community, he referred his reasons for judgment to ASIC to take whatever action it considers appropriate. 

Ross Rydge, Senior Associate & Stacey Taylor, Associate