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The Importance Of Default Notices On Disclaimer Of Onerous Property

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By Krisha Reddy, Law Clerk MST Lawyers and Alicia Hill, Principal, MST Lawyers

The recent decision of Justice Logan of the Federal Court in Australia and New Zealand Banking Group Limited v State of Queensland [2018] FCA 464 acts as a reminder to directors and insolvency practitioners of the importance of default notices in retaining contractual rights and enforceable securities. It discusses the operation of section 133 of the Bankruptcy Act 1966 (Cth) (Act) and how it can protect security holders against bankruptcy disclaimers and the doctrine of escheat.

Factual Background

On 6 November 2006, Mr Bates entered into a loan contract with the ANZ Bank (Bank), secured with a mortgage over property. On 8 December 2015, Mr Bates was sent a default notice in accordance with the National Credit Code and the Property Law Act 1974 (Qld). On 20 January 2016, Mr Bates became bankrupt. Relying upon its mortgage, the Bank started proceedings against Mr Bates. It obtained a judgment from the Court which gave it possession of the property. A contract of sale was then entered into by the Bank. On 17 May 2017, pursuant to section 133 of the Act, Mr Bates’ trustee in bankruptcy disclaimed the property as onerous in effect vesting the Property in the Crown (State of Queensland) denying the Bank the ability to sell the property.

Issues

The main issue that arose from this situation was the operation of sections 133(2) and 133(9) of the Act about the disclaiming of property. The relevant provisions are as follows:

Section 133(2)  A disclaimer under subsection (1) or (1A) operates to determine forthwith the rights, interests and liabilities of the bankrupt and his or her property in or in respect of the property disclaimed, and discharges the trustee from all personal liability in respect of the property disclaimed as from the date when the property vested in him or her, but does not, except so far as is necessary for the purpose of releasing the bankrupt and his or her property and the trustee from liability, affect the rights or liabilities of any other person.

Section 133(9)  The Court may, on application by a person either claiming an interest in, or being under a liability not discharged by this Act in respect of, disclaimed property, and after hearing such persons as it thinks fit, make an order, on such terms as the Court considers just and equitable, for the vesting of the property in, or delivery of the property to, a person entitled to it or a person in whom, or to whom, it seems to the Court to be just and equitable that it should be vested or delivered, or a trustee for that person.

Interpretation of section 133(2)

While section 133(2) provides for disclaimer of the bankrupt’s rights, interests and liabilities in or in respect of the property; it also discharges the bankruptcy trustee from all personal liability in respect of the disclaimed property from the date on which the property vested in the trustee.

However, the disclaimer does not affect the rights of other persons. Thus there is tension in section 133(2) in regards to what rights are actually terminated by the disclaimer and whether ANZ’s rights under its registered mortgage continued to apply.

Justice Logan observed that when there is a release from liability the contractual provisions of a mortgage will cease to apply and there will no longer be any personal covenant. However, if a default already exists when release from liability is made, then the right to sell that is vested in the mortgagee is not affected.

On the facts, there was a default notice issued to Mr Bates before the declaration of bankruptcy. This meant that the mortgage contractual provisions continued to apply and ANZ maintained its rights.

Interpretation of section 133(9)

The result of a disclaimer under section 133(2) is that the doctrine of escheat may be enlivened which has the effect of vesting the property in the Crown – which is why the State of Queensland was joined as a party to this case. The doctrine gives the Crown the property as the interest of the previous registered owner ceases to exist. The practical effect if the property was disclaimed was that ANZ would not have been able to take action to sell the property over which it had a mortgage because the Crown would have become the new owner with unqualified title.

However, section 133(9) of the Act provides that the Court may make any order it considers just and equitable for vesting property. Justice Logan considered the decision of Justice Rares in National Australian Bank Ltd v State of New South Wales (2009) 182 FCR 52 which found that the title to property does not escheat absolutely to the Crown because the Court has the power to vest title in someone else. The Bankruptcy Act (Commonwealth law) supplants State escheat law by force of section 109 of the Australian Constitution.

On the facts, ANZ met the criteria under section 133(9) which meant that it was able to get a vesting order in respect of the property to allow it to complete the sale of the property, pursuant to the original contract.

Practical Implications

For Security Holders

This case demonstrates the importance of sending default notices as soon as default occurs. The bank sent its default notice before the bankruptcy which allowed it to rely on the mortgage provisions, sell the property and realise some of its loss. However, if the default notice had been sent after bankruptcy, then the bank would have had no rights to possession of the property and would have been unable to exercise its mortgagee rights.

If you would like to discuss any aspect of this article further, please do not hesitate to email Alicia Hill or phone +61 3 8540 0200.