Deputy Commissioner of Taxation v Zappia  FCA 2152.
A pithy judgment of Jagot J provides helpful guidance on the principles applicable to the setting aside of a composition.
The power to set aside a composition
Pursuant to s 222(1) of the Bankruptcy Act 1966, the Court may set aside a composition if the terms of the agreement are unreasonable or are not calculated to benefit the creditors generally, or for any other reason. The principles were identified by Merkel J in Re Mills; Ex parte Lloyd’s (1997) 73 FCR 551 at 559 to 561 in respect of s 222 in its antecedent form (and applied to s 222 in its current form by Flick J in Moran v Robertson  FCA 371 at ). They are:
- Whether, after considering all the circumstances of the case, a greater opportunity to inquire into the debtor’s affairs and a more comprehensive explanation by the debtor is called for.
- If circumstances arise which “give cause for a suspicion” or to “arguable” causes of action which may benefit creditors then that can suffice to set aside the composition.
- It is not necessary to establish that the creditors will be, or even are more likely to be, advantaged by bankruptcy rather than the composition, but is sufficient if bankruptcy will afford a “prospect or possibility of economic advantage to creditors sufficient to justify the conclusion that it is in their interests to make the declaration”: Augustyn v Putnin (1988) 83 ALR 514 at 55.
- If the amount offered under the composition is small or trivial there may be no harm of any consequence to creditors for the composition to be set aside if other factors warrant that course.
- A Court may be more disposed to set aside a composition if no payments to creditors have been made pursuant to the composition.
The composition was set aside
Jagot J’s reasons for setting aside the composition (at  to ) were as follows.
- The creditors had not adopted a compensation that the trustee recommended. Due to the complexity of the bankrupt’s financial affairs, the trustee recommended that there be a public examination.
- The composition was trivial. The composition paid 1.98 cents in the dollar compared to a range of between 0.23 cents in the dollar and 1.29 cents in the dollar if the bankruptcy were to proceed. The triviality meant that little or no harm would be occasioned to creditors by setting aside the composition.
- There was evidence of equitable fraud. It emerged in evidence that the bankrupt had made representations to a number of creditors that he would be aiming to repay the money he owed to them irrespective of the composition. In a composition all creditors are “dealt with equally without the intrusion of any private bargain destroying that equality”: ET Fisher & Co Pty Ltd v English, Scottish and Australian Bank Ltd  64 CLR 84 at 91 per Starke J. The private bargain is a species of equitable fraud: Earl of Chesterfield v Janssen (1750) 2 Ves Sen 125; 28 ER 82 per Lord Hardwicke at 100 (as cited with approval by Owen J in Bell Group Ltd v Westpac Banking Corporation (No 9)  WASC 239; (2008) 70 ACSR 1 at ). His Lordship said at 100:
Where a debtor enters into a deed of composition with his creditors for 10s in the pound, or any other rate, attended with a proviso that all creditors executed this within a certain period, if the debtor privately agrees with one creditor to induce him to sign this deed, that he will pay or secure a greater sum in respect of his particular debt: in this there can be no particular deceit on the debtor, who is party thereto: but it tends to deceit of the other creditors, who relied on an equal composition, and did it out of compassion to the debtor. This court therefore relieves against all such underhand bargains.
A binding contract to the effect of the equitable fraud was not required. Jagot J held this factor “weighed heavily” in favour of the setting aside the composition.
- Some creditors provided affidavits which disclosed that they voted in favour of the composition for ulterior reasons. By way of explanation, some creditors said that they had voted for the composition for the purpose of assisting the bankrupt to re-establish his commercial affairs. Rather, it is their interest as creditors that is “of fundamental importance” of the legislative composition scheme.
- The complexity of the bankrupt’s affairs warranted further investigation, as the trustee recommended.
The facts of his case provide a helpful illustration of when a composition, especially one where there is a trivial return to creditors, will be set aside. It also provides a timely reminder that a deal outside the composition or other incentives offered to creditors to vote in favour of a composition is inimical to the composition itself and is likely to see it set aside.