Educational Resources Pty Ltd (in liq) v Hennessy, Poteri & Poteri [1996] QSC 99

IN THE SUPREME COURT OF QUEENSLAND Brisbane No. 1268 of 1993 Before the Hon Justice White [Educational Resources Pty Ltd v. Hennessy & Anor] BETWEEN: EDUCATIONAL RESOURCES PTY LTD (IN LIQUIDATION) First Plaintiff AND: PHILIP ARTHUR HENNESSY (in his capacity as liquidator of the First Plaintiff) Second Plaintiff AND: JAMES NICHOLAS POTERI and NICKI POTERI Defendants REASONS FOR JUDGMENT - WHITE J Judgment delivered 05/06/1996 CATCHWORDSSUIT against directors for general deficiency in trust funds held by company - breach of duties as directors. Counsel: Mr P Hack for plaintiffs Mr T Matthews for defendants (withdrew after refusal of adjournment) Solicitors: Australian Government Solicitor for plaintiffs Baker Johnson for defendants Hearing Date: 27 May 1996 -- 1 of 19 -- IN THE SUPREME COURT OF QUEENSLAND No. 1268 of 1993 [Educational Resources Pty Ltd v. Hennessy & Anor] BETWEEN: EDUCATIONAL RESOURCES PTY LTD (IN LIQUIDATION) First Plaintiff AND: PHILIP ARTHUR HENNESSY (in his capacity as liquidator of the First Plaintiff) Second Plaintiff AND: JAMES NICHOLAS POTERI and NICKI POTERI Defendants REASONS FOR JUDGMENT - WHITE J Judgment delivered 05/06/1996 The first plaintiff, ("Educational Resources") is a company in liquidation. It was ordered to be wound up on its own application in this court on 23 March 1993. The second plaintiff is the liquidator of the company. The defendants at all material times were the directors of the company and of two other companies relative to this action, Legal Research Pty Ltd and Australian College of Nannies Pty Ltd. They were appointed directors of Educational Resources on 20 December 1987, of Legal Research on 30 December 1988 and of Australian College of Nannies on 9 May 1991. On 7 January 1988 Educational Resources became the trustee of The James Nicholas Poteri Trust. -- 2 of 19 -- 2 Between 7 January 1988 and 12 September 1990 Educational Resources carried on the business, inter alia, of providing English language courses for overseas students under the name of Modern English Language College of Australia ("MELCA"). It had accreditation from the Australian Government as a provider of English Language Intensive Courses for Overseas Students ("Elicos") from 23 November 1988. The company entered into numerous agreements with overseas students for the provision of such courses. Relevantly those agreements contained express terms that in consideration of the payment by the student to Educational Resources of a sum of money representing prepaid tuition fees and prepaid living allowances Educational Resources would provide the student with tuition in an English language course and the student's accommodation and living expenses in Australia. It also provided that a full refund of prepaid tuition fees and prepaid living allowances would be made to each student in the event of that student not being granted a visa to come to Australia with the exception of an administration fee of $100. This action is concerned with fees received between 1989 and 1990 from some 302 overseas students the particulars of which are set out in a schedule to the amended statement of claim. Educational Resources received from them an amount of $1,503,428 comprising prepaid tuition expenses of $833,105 and prepaid living allowances of $626,622. None of the students referred to in the schedule was granted a visa to come to Australia to take up the English language courses. When the -- 3 of 19 -- 3 liquidator was appointed to the company there remained in the accounts of the company only the sum of $469,415.55. The plaintiffs allege that the moneys received by Educational Resources were impressed with trusts - in the case of the prepaid tuition fees, a trust for a purpose (Quistclose Investments Ltd v. Rolls Razor Ltd [1970] A.C. 567) and in the case of the living allowance, upon trust for the students. They allege that in breach of those trusts the defendants applied the funds held by Educational Resources for the general purposes of Educational Resources, for the benefit of themselves and for the benefit of third parties and that they are liable to the extent of the general deficiency between the amount of the trust funds and the amount recovered by the liquidator. Alternatively that they breached their obligations as directors of Educational Resources pursuant either to the Companies (Queensland) Code or the Corporations Law. In the defence and particulars the defendants assert that the moneys identified in the amended statement of claim were utilised for the proper purposes of Educational Resources or were moneys owing to some other entity and not the property of Educational Resources. The defence does not address the general deficiency claim other than to deny generally. It is necessary to say something about how the trial proceeded. When the case was called on, Mr Hack for the plaintiffs gave a brief opening and Mr T Matthews who appeared for the defendants indicated that the matter would take the five days that had been allocated to it. Mr Matthews then -- 4 of 19 -- 4 informed the court that the defendants were about to execute deeds pursuant to s.188 of the Bankruptcy Act assigning their property to Mr I Worrell. Upon the deeds being executed Mr Matthews sought an adjournment of the trial accepting that his client should pay the costs thrown away. The application for adjournment was opposed and I was not persuaded that there was any good reason why the matter should not proceed to trial. On that ruling Mr Matthews informed the court that the defendants did not wish to take further part in the trial, that they would not appear for themselves and he and his solicitors sought leave to withdraw. The trial then proceeded with Mr Hack calling his witnesses and tendering a considerable amount of documentary evidence, much of it from the oral examination of the defendants in the Magistrates Court in August 1993. Background The business names extract shows that James Poteri, one of the defendants, carried on business under the name Modern English Language College of Australia (MELCA) from 30 October 1987 to 7 January 1988. Educational Resources carried on business under that name from 7 January 1988 to 12 September 1990 and Legal Research carried on business under that name from 12 September 1990. Legal Research was wound up in late 1992 on an application by the Attorney-General of the Commonwealth for non-payment of costs in respect of a mandatory injunction to comply with notices given under the Overseas Students (Refunds) Act. Educational Resources purchased from the Australian College of Nannies the licence to use certain -- 5 of 19 -- 5 courses for childcare training in 1989. It seems likely that as a consequence of political events in the People's Republic of China known as the Tiananmen Square Massacre in June 1989 the Australian Government became more selective in granting visas to Chinese students to study English in Australia. In any event the students who had been accepted by MELCA to study English courses in Queensland, who had pre-paid their fees and whose names are set out in the schedule to the amended statement of claim did not obtain visas to come to Australia. Mr Edward Fisher, counsellor for Education Employment and Training in the Australian Embassy in Beijing in the People's Republic of China gave evidence. He was earlier employed within the Commonwealth Department of Education Employment and Training in what was known as the China Task Force. This had been established to organise and arrange the reimbursement of prepaid fees and expenses to intending overseas students who were unable to obtain a visa to enter Australia and who were subsequently unable to obtain a refund from the institution at which they were enrolled. In July 1990 the Australian Government decided that it would refund the prepaid fees and expenses to the overseas students in consideration of and in exchange for deeds of assignment. The Overseas Students (Refunds) Act 1990 was passed for the purpose, inter alia, of facilitating the provision of refunds to students and the recovery of moneys so paid from educational institutions. The Act enabled the Commonwealth to require the educational -- 6 of 19 -- 6 institution to provide details of the moneys paid to it by overseas students. An order pursuant to s.5 of the Act was made by Williams J in this court on 19 March 1992 requiring Legal Research to provide that information about students enrolled with MELCA who had paid fees and not obtained a visa. Although the business name MELCA was owned by Legal Resources from September 1990 it seems that Educational Resources at all relevant times retained the funds previously deposited with it when operating the business of the college. Mr Fisher with the assistance of his staff prepared the schedule to the amended statement of claim which was derived from the original documents obtained from the college and from action taken in the Australian Embassy at Beijing. Each student provided a claim form declaration to establish the claim and its authenticity. A notary of the People's Republic of China authenticated the identity and signature of the claim form declarant. The claimant student executed a deed of assignment in favour of the Commonwealth of Australia in consideration of which the Commonwealth made a refund payment. Payments were made in person to the students at the Australian Embassy in most cases towards the end of 1991. The Commonwealth refunded to the student the $100 administration fee which the agreement with the college stated would be retained by it in the event of the student not being given a visa to enter Australia, as an ex gratia payment. A number of actions involving Legal Research and Educational Resources was commenced in 1992. The Commonwealth -- 7 of 19 -- 7 of Australia sued Legal Research in Action No 1259 of 1992 in this court in the sum of $1,474,228 on the assignment of debts from the overseas students. That action ceased when it was conceded to have been commenced against the wrong defendant and ought to have been against Educational Resources. A fresh action was commenced against Educational Resources. In October 1992 the Australian Taxation Office assessed as income the sums held by Educational Resources and froze the balance of the company's accounts with the Bank of Queensland. Educational Resources commenced an action against the Deputy Commissioner of Taxation in the Federal Court for declarations and the release of those funds. Mr Hack indicated that the action against Educational Resources by the Commonwealth to recover the amount of the refunds had not proceeded. Mr Matthews foreshadowed at the beginning of the trial that the defendants would argue that the refunds owing to the students were not debts and not assignable. Since this suit does not concern itself with the assignment or, indeed, recovery by the students, I do not propose to consider this point. General Deficiency of Funds Through 1990 and until August 1991 the defendants, through James Poteri discussed aspects of the refunding of the fees to the overseas students with the company's solicitors. It would not be an exaggeration to conclude from the solicitor's diary notes and Mr Peter Archos' evidence in the Magistrates Court that they were extremely reluctant to direct the company to -- 8 of 19 -- 8 refund any moneys. By early August 1991 the solicitors for Educational Resources had advised Mr Poteri that both the tuition fees and the living allowance fees were each impressed with a trust and under no circumstances ought the funds be dealt with. In his affidavit of October 1992 in Educational Resources' application against the Deputy Commissioner of Taxation, Mr Poteri as director of Educational Resources and Legal Research referred to the action by the Commonwealth to recover the pre-paid fees from Educational Resources which had been assigned to it by the students and swore that the whole of the moneys held on behalf of Educational Resources by the Bank of Queensland were funds received from the students and were held as trustee for the students and were not assessable income in its hands. Mr Poteri also swore that no money was received in the financial year to 30 June 1991 by the company and that the only source of income for the company was interest on the funds. On the appointment of the liquidator on 23 March 1993 funds amounting to $469,415.55 were recovered from the Bank of Queensland from an account in the name of Educational Resources Pty Ltd as trustee for "The James Nicholas Poteri Family Trust". The liquidator has identified student receipts of $1,503,428. The deficiency is said to be $1,034,012.45 being those receipts less the funds recovered at the date of the winding up of the company. Although Mr Klein of the liquidator's office who has examined the books and records of Educational Resources cannot say that each of the individual -- 9 of 19 -- 9 receipts from students were received and banked by the company because of a lack of company records, nonetheless he has been able to identify exactly the same amounts at or around the date that the sums were sent from China as going into Educational Resources' account. The totals of the bank deposit slips reconcile with overseas student funds received during the period February 1989 to August 1990 and were in the total sum of $2,874,429.35. A review of the banking records of Educational Resources did not reveal any evidence of the overseas student funds being repaid. Mr Poteri in his affidavit sworn on 5 March 1992 in the action by the Attorney- General of the Commonwealth against Legal Research claimed that $35,000 had been repaid but Mr Klein did not produce evidence to support this assertion and it was not pleaded to in the defence. The money ($1,503,428) was clearly advanced to Educational Resources for particular purposes by the overseas students. It was, on receipt by the company, clothed with specific trusts and it never became part of the general funds of the company. When those purposes failed, quite apart from the terms of the agreement between the student and the company, the student was entitled to have the money refunded to him or her. The two defendants were the only directors of the company and, from the material, the only persons involved in the day to day decisions about the affairs of the company. The disposition of much of the money has been traced by the liquidator, but not all of it, but it is not necessary to do so for the purposes of recovery -- 10 of 19 -- 10 for breach under the general law. The company was the trustee of the funds. The absence of an amount of just over $1 million in the funds held on trust by the company and the absence of any explanation for that deficiency leads to an inference that the funds have been dealt with otherwise that in accordance with the terms of the trust. The defendants controlled the company. They are persons who have knowingly caused the company's breach of trust on the principles enunciated in and developed from Barnes v. Addy (1874) 9 Ch App 244. The defendants have caused trust moneys held by Educational Resources to be paid away and have exposed the company to suit by the beneficiaries of the trusts to the extent of the deficiency. The company is now out of their control and seeks the recovery of those funds. The agreement with each student was that the tuition and living allowance fees would be refunded less an administrative charge of $100 in the event that the visa was not obtained. I have concluded the $100 per student could fall into the general funds of the company. I am satisfied that the deficiency in trust funds for which the defendants are liable is $1,003,812.45 being the total of the sums received less the amount in the company's account on liquidation less $30,200 being the administration charge. Breach of Duty as Directors The plaintiffs claims from the defendant on the alternate basis of breach of their duties as directors. As directors of Educational Resources the defendants had duties imposed upon them either by virtue of s.229 of the Code or s.232 of the Law. -- 11 of 19 -- 11 Certain sums have been identified which are alleged to have been dealt with in breach of those obligations of honesty and diligence and which have improperly given an advantage either to the defendants or others. (a) Purchase of a BMW On 2 August 1989 a deposit of $5,000 was paid on the purchase of a new BMW motor vehicle by way of a cheque from Educational Resources' account. On 18 August 1989 the balance of the purchase price for the BMW was made with funds from Educational Resources' Bank of Queensland account. The purchase order for the motor vehicle on 2 August 1989 shows the purchaser as JN Poteri. The motor vehicle register identifies the owner of the BMW as "K & N Services" a business name which has never been registered. The motor vehicle was used and treated by the defendants as their personal property. In their defence the defendants claim that the BMW was transferred to them at the date of purchase in lieu of wages and salary owed. The vehicle at no time was shown as an asset in the company records. During 1989 to 1992 company records show that amounts were paid by Education Resources for the BMW with respect to registration, insurance and maintenance which were not shown as employee benefits. The Australian Taxation Office investigated the defendants' personal affairs in 1992 and indicated that they would be assessed personally for the benefit of the motor vehicle. The defendants asserted that the car was paid as part of their entitlements. According to Mr Woodhouse, the external company accountant, the first time that fringe benefits tax -- 12 of 19 -- 12 returns were prepared showing the BMW as an employee benefit was in late November 1992. It seems clear that the defendants utilised their position as directors to obtain a benefit for themselves and not in the ordinary course of their relationship with the company as employer and employee. (b) Expenditure of $337,881 The business names register shows that the MELCA name was transferred from Educational Resources to Legal Research on 12 September 1990 but that the cash accumulated remained with Educational Resources. The same register shows that the Australian College of Nannies name was deregistered on 12 May 1991. Australian College of Nannies Pty Ltd took over that business by December 1992. Mr Klein examined the bank accounts and documents of the company and concluded that there was no evidence of any trading income for Educational Resources after 30 June 1991. Nonetheless Educational Resources in the year ended 30 June 1992 had expenditure of $337,881 as appeared in its financial accounts. Mr Klein could find no reason why expenditure of that order was incurred with respect to its own activities subject only to an amount of approximately $10,000 relating to the Australian College of Nannies, a business activity of Educational Resources. Mr Klein identified the expenditure which was made from the funds withdrawn from Educational Resources' four accounts during this period. Account No 3, one of two with the National Australia Bank, was described on the cheque books as the MELCA account. Mr Klein found that a significant number of cheque -- 13 of 19 -- 13 payments went through the account after 30 June 1991 but the account became inactive from 6 December 1991. The payments were consistent with the operation of a business being for rent, salaries, periodic disbursements of living allowances to students and office expenses. They were mainly for the period July to December 1991. Mr Poteri swore in October 1992 that no money was received by the company in the financial year to 30 June 1991 and by inference in para 14 of his affidavit that it had ceased to carry on the college activities. The MELCA business name was transferred to Legal Research on 12 September 1990 and it seems likely that the expenditure was on behalf of that entity. No substantial inter-company loan account existed between Legal Research and Educational Resources. Educational Resources' profit and loss account shows the expenditure as being debited to its expense accounts. The cheque book for the second National Australia Bank account describes it as the ACN (Australian College of Nannies) account. Payments between July and August 1991 totalled approximately $10,000 and thereafter the account was inactive. The payments appear to relate to the operation of a Nannies College, for example, rent, salaries, books, advertising and office expenses. Again no inter-company account with the Australian College of Nannies existed but in Educational Resources' balance sheet the expenditure is debited to Educational Resources' profit and loss account. Mr Klein concluded that although Educational Resources' documentation was not comprehensive it was clear that it had no trading income after 30 June 1991, that the MELCA and -- 14 of 19 -- 14 Australian College of Nannies business names had been transferred and the large number of expenses after that date related to the business activities of other companies. I am prepared to infer that in those circumstances the expenditure of $337,881 was a misuse of the company's funds by its directors for purposes other than the legitimate purposes of the company. $70,000 on overseas holidays The plaintiffs have alleged that the defendants permitted or procured the company to pay a total of $79,000 for the costs and expenses of the defendants, their two children and the mother of the female defendant to take a holiday in Singapore, Greece, Cyprus, Spain and the United Kingdom in August 1992 which was an expenditure not for the benefit of Educational Resources. In their defence and the particulars to it the defendants say that the trip was to promote the first plaintiff's business in those countries. They denied that Educational Resources paid the costs of the defendants' two children and the female defendant's mother in accompanying them and that Mr Poteri personally paid costs in the sum of $11,460.80 on behalf of those fellow travellers. The Bank of Queensland opened an account on 13 August 1992 in the name of Educational Resources as trustee for The James Nicholas Poteri Family Trust which was closed the following day. The principal deposit was $628,165.11. Of that money $49,000 and $14,000 were used to purchase Bank of Queensland Savings Bank Limited bank cheques made payable to AMEX. That -- 15 of 19 -- 15 acronym I accept as being for American Express International. $16,000 was credited to a Bank of Queensland Limited Visa card in the name of James Poteri. In the absence of particulars in the defence or in the particulars themselves and having regard to the answers given at the examination before the Magistrate by Mr Poteri I am satisfied that the payments of those amounts at the direction of the defendants was not done honestly for the benefit of the business of the company but for the personal purposes of the defendants. $14,357.50 to Francis & McGregor Mr Peter Arcos formerly of the firm Francis & McGregor the solicitors for the companies associated with the defendants and for the defendants personally, gave evidence that the amount of $14,357.50 was referrable to the legal costs incurred in litigation involving Legal Research. As has been mentioned, the litigation involved an application by the Commonwealth for compliance with a statutory notice issued pursuant to Overseas Students (Refunds) Act. Legal Research pursued this litigation to a special leave application to the High Court. It was unsuccessful at all levels. The letter from the Bank of Queensland, to which I have referred, shows that a bank cheque was made payable to Francis & McGregor from the funds held on behalf of Educational Resources. In their defence the defendants allege that that sum was paid for legal work carried out for Educational Resources. It was not until after the liquidator had access to the books and accounts of Educational Resources and Legal Research that he concluded that Educational -- 16 of 19 -- 16 Resources continued to hold moneys on behalf of the overseas students. The invoices from Francis & McGregor are in respect of legal fees for Legal Research supported by receipts and trust account ledgers. At no time was the point taken that the notices were directed to the wrong entity. The evidence supports the conclusion that Legal Research was then operating the college. Even if it is arguable that the legal costs were incurred on behalf of Educational Resources the conduct of the defendants as directors of both companies was, I am prepared to infer, an attempt to avoid the revelation of the deficiencies in the funds held on trust and was not for the proper purposes of the company. $72,000 paid to Australian College of Nannies The amended statement of claim alleges that on 14 August 1992 $72,000 was paid to the Australian College of Nannies Pty Ltd at a time when the defendants knew or ought to have known that it did not have the capacity to repay that sum. The defendants admit that the money was paid but allege that it was for reimbursement of fees received by Educational Resources on behalf of the Australian College of Nannies in or about December 1991 and has set out to its defence a schedule of individual receipts totalling $73,305. In the period ended 31 December 1991 an analysis by Hart Larwill, Education Resources' external accountant, shows that $72,475 of fees for courses run by Educational Resources were banked to the Australian College of Nannies Pty Ltd. There is nothing shown in Educational Resources' financial statement in respect of a loan account for -- 17 of 19 -- 17 Australian College of Nannies. As at 30 June 1992, $99,965 was owed to Educational Resources by Australian College of Nannies. There were no entries relating to funds or fees received on behalf of the Australian College of Nannies. There are no bank deposit slips bearing names or amounts which reconcile with the defendants' schedule. The only deposits into Educational Resources' accounts during the relevant period were IBD deposits and were matured to Educational Resources' cheque account. No other receipts are shown for the company during the relevant period. It seems an inevitable conclusion that the $72,000 was simply paid to the Australian College of Nannies Pty Ltd when the defendants knew that it was erased and would not be able to repay the loan in breach of its duty of diligence to the company. Conclusion I am persuaded that the defendants were persons knowingly dealing in trust moneys of which Educational Resources was the trustee contrary to the terms of the trust. There was a general deficiency in the trust funds held by Educational Resources as a consequence of the conduct of the defendants. I give judgment against each of the defendants in the sum of $1,003,812.45. Interest is sought at 11% per annum for six years, that is, from 1989. The students were paid for the most part at the end of 1991, although interest vis-à-vis the Commonwealth is not an issue here. The deficiency in the funds took place from 1989 to 1992. Taking a broad approach I will allow interest at 11% for 4 years. That is $441,677.50. -- 18 of 19 -- 18 If I am incorrect in concluding that the defendants knowingly dealt with trust moneys in breach of the terms of the trust then I conclude that in breach of their duties as directors pursuant either to the Code or the Law they have caused $718,238.50 of the money of Educational Resources to be lost to the company. Accordingly in the alternative I give judgment against each of the defendants in that sum together with interest at 11% per annum. I will calculate interest at four years. That amounts to $316,024.94. Accordingly, there will be judgment entered against the defendants in the sum of $1,003,812.45 together with interest in the sum of $441,677.50. Alternatively judgment against the defendants in the sum of $718,238.50 together with interest thereon the sum of $316,024.94. The defendants must pay the plaintiffs' cost of and incidental to the action to be taxed. -- 19 of 19 --