The Bruton Holdings decision

Introduction

The Australian insolvency landscape stands to be significantly affected by the recent decision of the Full Federal Court in Commissioner of Taxation v Bruton Holdings Pty Limited (in liq) [2008] FCAFC 184 (Bruton Holdings).¹ The case confirms the ability of the Commissioner of Taxation (Commissioner), in certain circumstances, to leap-frog all other creditors in a liquidation, including secured creditors.

The decision of the Full Federal Court provides that the Commissioner can effectively garnish debts owed by third parties to a company/taxpayer after winding up has commenced. This means that the Commissioner can enjoy preferential treatment over other creditors, and have first call on any moneys coming into the company/taxpayer, irrespective of the position of secured or unsecured credits. It also means, in future, there may be:

• fewer assets available for payment of other creditors on a winding up, and   
• a contraction in the funds available to liquidators to pursue each winding up in a way that maximises the return to all creditors.²

The decision stands in stark contrast to considered insolvency policy in Australia and sounds a warning bell for creditors, administrators and insolvency practitioners, particularly in the present economic and credit environment. Indeed, the Insolvency Practitioners Association (IPA) has advised its membership that it has been in contact with the Australian Taxation Office concerning the decision. The Commissioner has indicated that he does not intend to change the ‘longstanding approach whereby he does not seek to use section 260-5 powers after the date of a company/taxpayer taxpayer’s liquidation’.³

Whether this is the case remains to be seen. What is apparent is that the affirmation of the Commissioner’s ability to assert, at will, his priority over debts due to companies in liquidation has introduced a disturbing element of unpredictability into an area that is likely to see greater activity over the coming months, and possibly years—with plenty of opportunity for the Commissioner to make use (or not) of this power. 

Factual background

The taxpayer, Bruton Holdings Pty Limited (in liquidation) (Bruton) was the trustee of the Bruton Educational Trust (Trust). On 28 February 2007, Bruton entered administration by resolution of the sole director. On the same day, $450,000 was placed in the trust account of Bruton’s lawyers to cover costs and disbursement in connection with an appeal against Bruton’s failed application for endorsement as an income tax exempt charity.

In March 2007, the Commissioner issued a Notice of Assessment to Bruton (in its capacity as trustee of the Trust) for a tax debt in the amount of $7,715,873.73 for the year ending 30 June 2004 (tax liability). On 30 April 2007, Bruton was placed in creditors’ voluntary liquidation – with the effect that the deemed commencement date of the winding up was 28 February 2007.

In May 2007, the Commissioner served notices under section 260-5 of Schedule 1 to the Taxation Administration Act 1953 (Cth) on Bruton’s lawyers seeking recovery of remaining $447,420.20 held in its trust account (Notice). Section 260-5 permits the Commissioner to serve notice on a third party who ‘owes or may later owe’ money to a taxpayer requiring direct payment of the debt to the Commissioner, up to the amount of the taxpayer’s tax-related liability.⁴

Among other things, Bruton tried to resist the Notice on the grounds that it conflicted with section 500(1) of the Corporations Act 2001 (Cth) (Corporations Act):

‘any attachment, sequestration, distress or execution put in force against the property of [a] company after the passing of [a] resolution for voluntary winding up is void’.⁵

The validity of the Commissioner’s claim to the $447,420.20, turned on whether the relevant notice under section 260-5, issued after the commencement of winding up, created an ‘attachment’ on Bruton’s property. If so, the notice would have no effect under section 500.

The Full Federal Court decided that a section 260-5 notice did not create an ‘attachment’ for the purposes of the Corporations Act.

Relationship between section 260-5 and winding up provisions of the Corporations Act

Bruton Holdings is not the first case to consider the meaning of ‘attachment’. An earlier Full Federal Court decision had looked at the same question in the context of bankruptcy legislation. In Commissioner of Taxation v Donnelly (Donnelly),⁶ the Full Federal Court had to decide whether moneys ‘garnished’ by the Commissioner before the individual taxpayer became bankrupt could be recovered by the trustee in bankruptcy.

Section 118(1) of the Bankruptcy Act 1966 (Cth) applies to creditors who have received money from a bankrupt/taxpayer during the period of six months leading up to the presentation of a petition under the Act. Relevantly, if the creditor received a payment within that period as the result of the ‘attachment’ of a debt due to the taxpayer, the creditor must repay the trustee in bankruptcy the difference between the amount received and the ‘taxed costs’ of the attachment.

In Donnelly, the Full Federal Court held that the word ‘attachment’ should be given a narrow meaning – that is, limited to court-based methods of recovering debt. The decision was based, in part, on the fact that section 118(1) refers to ‘taxed costs’. This was said to suggest a ‘curial context’.⁷ On this analysis, a notice served by the Commissioner is not an ‘attachment’.

After Donnelly but before Bruton Holdings, another Full Federal Court considered the meaning of ‘attachment’ in connection with the winding up provisions of the Corporations Act. The court in Macquarie Health Corp Ltd v Commissioner of Taxation⁹ identified various arguments against giving a narrow meaning to ‘attachment’ in the context of a Corporations Act winding up, but did not decide the point. Those arguments included:⁹

1. unlike section 118 of the Bankruptcy Act, relevant Corporations Act provisions do not talk about the ‘taxed costs’ of an attachment, although section 569 of the Corporations Act does
2. the reasoning in Donnelly does not necessarily apply by analogy to the use of the word ‘attachment’ in the Corporations Act. For example, the reasoning in Donnelly was based, in part, on the legislative history of the Bankruptcy Act, and
3. unlike the Bankruptcy Act, the Corporations Act provisions apply to non-court processes because they include reference to ‘distress’ as well as the court-based procedures of ‘sequestration’ and ‘execution’.

In Bruton Holdings, at first instance, Justice Allsop stated that he was not bound by the decision in Donnelly and decided that a notice served by the Commissioner under section 260-5 is an ‘attachment’ for the purposes of the Corporations Act. Justice Allsop based his decision on three key grounds:¹⁰

1. the reasoning in Macquarie Health
2. construing ‘attachment’ so that it does not include a notice under section 260-5 would be inconsistent with the priority provisions of the Corporations Act, and
3. the Crown priority for tax debts has been extinguished.

On appeal, the Full Federal Court preferred the approach in Donnelly and found that the Commissioner’s notice was not an ‘attachment’ for the purposes of section 500 of the Corporations Act.¹¹ And by implication, that the Commissioner could validly serve such a notice after the commencement of winding up.

The Full Court did not otherwise engage with the issues identified in Macquarie Health, observing that the decision in Donnelly had been around since 1989 and had ‘not prompted any amendment to the bankruptcy legislation or change of language in the corporations legislation’.¹² In terms of the remaining steps in Justice Allsop's reasoning, the Full Court was not persuaded that the ‘ending of the Crown priority for tax debts for many years’ should influence the meaning attributed to the word ‘attachment’ in the Corporations Act.¹³

Underlying policy framework - trend away from Crown priority

At the heart of insolvency law is said to lie the principle of pari passu:

It is a fundamental objective of the law of insolvency to achieve a rateable, that is to say pari passu, distribution of the uncharged assets of the insolvent among the unsecured creditors.¹⁴

The Australian Law Reform Commission’s Harmer Report into Australian insolvency laws of 1988 concluded that this principle of equality should be maintained at all times, subject only to qualifications to preserve property rights/securities and in order to encourage the effective administration of insolvent estates.¹⁵ The Harmer Report effectively recommended the retention of only two categories of priority, as proposed in the consultation paper of the previous year:¹⁶

1. administration costs—on the basis that creditors have a ‘community of interest in having a common agent to maximise a fund for distribution’,¹⁷ and
2. employee benefits.

The Commissioner’s historical priority had been significantly eroded by legislative amendment since the early 1980s.¹⁸ Indeed, by the time of the Harmer Report, the Commissioner’s priority ranking over unsecured creditors (excluding the costs of the administration) was limited to unremitted tax instalment deductions, prescribed payments deductions and natural resource or royalty payment deductions, and unpaid withholding tax.¹⁹

The Harmer Report effectively concluded that the Commissioner’s priority over unsecured creditors on even these limited grounds was not justified. The recommendation that these priorities accorded to the Commissioner be abolished found implementation in the enactment of the Insolvency (Tax Priorities) Legislation Amendment Act 1993 (Cth).²⁰ Since that time, the Commissioner has not had the benefit of outright priority ranking in insolvency. However, in return for that loss of priority, the Commissioner gained new powers to pursue the directors of a company that has failed to remit certain amounts to the ATO. Division 9 of the Income Tax Assessment Act 1936 (Cth) imposes personal liability on the directors of the company/taxpayer for unpaid remittances—recoverable by the Commissioner under the new regime of Director Penalty Notices.

Practical consequences

On the authority of Bruton Holdings, the Commissioner has been confirmed as ranking ahead of both the liquidator and employees in his access to debts owed by third parties. The Commissioner can, at a time of his choosing after winding up has commenced, issue a notice under section 260-5 and ‘leap-frog’ the liquidator’s access to unrealised debt. This has the potential to severely disrupt the role of the liquidator and to undermine the creditors’ ‘community of interest’.

The observation of the Full Federal Court in Bruton Holdings that the Commissioner has always had the capacity to affect priorities by the service of a section 260-5 notice prior to the commencing of a winding up²¹ ignores the difficulties that would be caused to liquidators who may rely on the availability of funds expected to flow into a liquidation only to find that pool abruptly diminished where access to third party debt is suddenly removed by way of a section 260-5 notice.

The Commissioner’s indication that he does not intend to alter his policy to section 260-5 is a welcome recognition of the potential difficulties in this area. However, the Commissioner has retained substantial flexibility for himself in applying that policy; how he applies the policy may become particularly important at a time when there are increasing levels of distressed companies, for many of whom book debts will be a major asset.

Conclusion

Liquidation has been described as a ‘procedure of an inherently collective nature’.²² This notion of ‘collectivity’ is undermined where priority is conferred upon one class of unsecured creditor at the expense of all others. The Commissioner’s historical priority in insolvency was the subject of attention by legislative and law reform bodies throughout the 1980s. The culmination of those efforts was the ending of the Commissioner’s priority.

The effect of the decision in Bruton Holdings cuts across this policy outcome by validating the potential for service of notices under section 260-5. Although the Commissioner has indicated that he will not depart from his existing policy, this may provide little comfort to insolvency practitioners seeking to navigate complex liquidations.

That such important consequences could flow from the differing views about what is meant by ‘attachment’ and the inherent difficulty in deciding between the competing meanings—as demonstrated by the conflicting views expressed in Donnelly, Macquarie Health and by each of Justice Allsop and the Full Court in Bruton Holdings—justifies legislative intervention to clarify the position and promote the policy of the law.

This article was written by Paul Wenk, Partner and Isabel Knott, Solicitor, Melbourne.

Endnotes

1. The time for filing an application for special leave to appeal to the High Court expired on 29 December 2008. 
2. The case also raises important questions about the payment of liquidators’ costs in the cases of liquidation of corporate trustees. Importantly, this aspect of the case was not decided by the Full Federal Court but will fall for decision if, as foreshadowed by the Full Court, the case continues before a single judge.
3. Insolvency Practitioners Association, Practice Alert: ATO response to Bruton Holdings – use of garnishee power and liquidation, (accessed 4 February 2009). This appears to be at odds with the facts of the case – in Bruton Holdings, administration commenced 28 February 2007, winding up being deemed to commence on the same date, and the Commissioner’s section 260-5 notices were issued on 9 May 2007.
4. Section 260-5 applies to a tax-related liability, judgment debt for a tax-related liability, the costs for such a judgment debt or any amount payable by a taxpayer to the Commissioner upon order of a court following conviction for an offence against tax law: section 260-5(1)(a)-(d).
5. The same prohibition applies  in the case of court-ordered winding up under section 468(4).
6. (1989) 25 FCR 432 (Donnelly).
7. See Bruton Holdings [2008] FCAFC 184, [66].
8. (1999) 169 ALR 16 (Macquarie Health).
9. Ibid [109] – [118].
10. Bruton Holdings [2007] FCA 1643, [56].
11. Bruton Holdings [2008] FCAFC 184, [72].
12. Ibid.
13. The Court made an interesting suggestion that, although there was no inconsistency between allowing section 260-5 to operate after winding up has commenced and the system of priorities laid down by the Corporations Act, section 501 may affect the operation of a notice. Section 501 applies in the case of voluntary winding up and provides that the property of a company/taxpayer must be ‘applied in satisfaction of its liabilities equally’ subject only to preferential payments under the Corporations Act. Section 501 may ‘override any later charge created by a s 260-5 notice’. The Court had not, however, had the benefit of argument directed to that section; so that whether or not this is correct will need to be resolved on another occasion but the application of section 501 to moneys recovered by the Commissioner through service of a section 260-5 notice after the commencement of the winding up may be of significant practical importance.
14. Report of the Review Committee on Insolvency Law and Practice presented to the United Kingdom Parliament in June 1982 (Chairman: Sir Kenneth Cork), 1396 cited in Australian Law Reform Commission, General Insolvency Inquiry, Report No 45, AGPS, Canberra 1988, 713 (Harmer Report).
15. Ibid 713.
16. Ibid 715.
17. Ibid 717.
18. Including the enactment of the Taxation Debts (Abolition of Crown Priority) Act 1980 (Cth) and the Crown Debts (Priority) Act 1981 (Cth).
19. Harmer Report, 733. The Commissioner’s priority over these amounts was preserved by specific provisions of the Income Tax Assessment Act 1936 (Cth).
20. See discussion in Grownow, M, McPherson, B H (Justice, Mason, R, McPhersons Law of Company/taxpayer Liquidation , Law Book Company/taxpayer (2006), [13.1300].
21. Bruton Holdings [2008] FCAFC 184, [64].
22. Grownow, M, McPherson, B H (Justice, Mason, R, McPhersons Law of Company/taxpayer Liquidation , Law Book Company/taxpayer (2006), [1.20].

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