TGIF 26 June 2020 – Supreme Court declines to direct sale of a property which would buy out of guarantor’s rights of indemnity below value

This week’s TGIF considers In the matter of Fellmane Pty Ltd (in liq) [2020] NSWSC 595, a recent decision in which the NSW Supreme Court declined to give directions approving a proposed transaction proposed by a liquidator of the trustee and the receiver of that trust which would have extinguished the trustee’s right of indemnity against the principal debtor.

Key takeaways

• All reasonable steps must be taken by a receiver to obtain the best outcome that can be negotiated in the circumstances for a sale, particularly having regard to the security and liability position of all parties.
  
  
• The court will not look favourably upon the exclusion of the guarantor’s right of indemnity and subrogation for consideration of an amount that is considerably less than the value of the security.
  
  
• Upon being asked to make directions, the Court will not interrogate “commercial” decisions but nor will it simply “rubber-stamp” proposals.

Background

Mr Brendan Copeland, in his joint capacities as the court-appointed receiver and manager of the Battaglia Family Trust (the Trust) and as liquidator of its former trustee, Fellmane Pty Ltd (Fellmane), sought directions from the Court in relation to the proposed sale of the sole asset of the Trust, being a property in Gerroa (the Property).

Under a Deed of Proposed Transfer and Release (Deed), Fellmane proposed to sell its sole asset to a related entity Batfamt Pty Ltd (Batfamt). The shares in Batfamt were jointly held by Mrs Battaglia and her son.

The Property was existing security for loans owed by Mrs Battaglia to NAB under a guarantee given by Fellmane. Mrs Battaglia’s loans were also secured by mortgages over 2 other properties.

Mr Copeland contended that the Deed was advantageous to Fellmane and that the transfer of the Property to Batfamt would result in a greater cash return compared to a public sale of the Property because the sale price was above the known valuations of the Property. He further submitted that the Deed would reduce Fellmane’s exposure to NAB by discharging part of its obligations under its guarantee.

SX Projects Pty Ltd (SX Projects) and 330 Co (the Contradictors), each with unsecured claims against Fellmane totalling at least $2 million, objected to the terms of the proposed transfer. They submitted that the Property should be sold at a public auction and asserted that Fellmane should exercise any rights of subrogation over the other NAB-held securities from Mrs Battaglia on the basis of its part payment of her debt to NAB.

What legal issues arose?

In considering whether to make the directions sought, the Court was required to consider the following legal impacts of the proposed transaction:

1. whether a right of subrogation arises when a guarantor repays part of a debt;
   
   
2. whether the proposed transaction allowed Fellmane to retain its right of indemnity against Mrs Battaglia as the principal debtor; and
   
   
3. whether the proposed transaction allowed Fellmane to retain its right of indemnity against the Property as a Trust asset.

How did the Court decide the issues?

Did Fellmane have a right of subrogation to other securities granted by Mrs Battaglia?

On the issue of subrogation, the Court confirmed that part payment of a debt only gives rise to the ‘potential’ availability of subrogation and that this right is only ‘crystallised’ and enforceable only upon the payment of the debt in full. As any sale of the Property would repay only part of the $3.7 million owed by Mrs Battaglia to NAB, Fellmane’s guarantees would not be discharged and no right of subrogation to the securities held by NAB over Mrs Battaglia’s other properties would arise. Accordingly, the part payment alone did not assist Fellmane in obtaining any rights of subrogation.

Did Fellmane have a right of indemnity against Mrs Battaglia as the principal debtor?

The Court confirmed that a guarantor’s right of indemnity against a principal debtor arises where payment, whether in whole or in part, and whether by money, property, securities or other means, is made to the creditor in reduction of the debt.

However, the Court observed that the Deed did not contemplate any payment directly from Fellmane to NAB in reduction of Mrs Battaglia’s debt to NAB. Accordingly, Fellmane had no right of indemnity against Mrs Battaglia as a result of its Property being effectively used to repay part of Mrs Battaglia’s debt. That would leave Fellmane worse off overall.

Did Fellmane retain its right of indemnity against the Gerroa property under the Deed?

Ordinarily, Fellmane as a former trustee, could expect a right of indemnity over the trust assets even after being removed from its role as trustee. The Court held that clauses 6.6 and 6.7 in the Deed excluded that right of indemnity upon the Property being transferred to Batfamt. Again, this would leave Fellmane worse off under the proposed transaction.

Outcome

Upon being asked to make directions, Gleeson J observed that it is not the role of the Court to make commercial judgments. That said, the Court viewed the legal effects of the proposed transaction and considered them to be unjustified because the Court could not be satisfied that Mr Copeland had given sufficient and appropriate consideration to the effect of the transaction and in particular the absence of Fellmane’s right of indemnity against Mrs Battaglia. This was important given Fellmane’s obligations to Mrs Battaglia under its guarantee.  

Further, Gleeson J considered that the sale process had been initiated when Mr Copeland was unaware of Fellmane’s guarantee of Mrs Battaglia’s total indebtedness to NAB, and that he had been negotiating with a singular related party. Mr Copeland had not satisfied the Court that he had ensured that all reasonable steps had been taken to obtain the best possible outcome for Fellmane which was particularly important given it was proposing to transact with a related party.

Comment

This decision endorses the principle that a guarantor’s right of indemnity against the principal debtor and its right of indemnity from trust assets cannot be ‘bought out’ in a proposed transaction, particularly where there are doubts about the efficacy of the sale process. Ultimately, the Court would not give directions approving a proposed transaction that would unjustifiably disadvantage one party at the expense of another.