Even banks have that ‘not happy Jan’ moment.
Insolvency practitioners frequently deal with issues relating to the validity of a security document; however, it is a little more unusual and surprising when it involves a major bank.
In one of our bankrupt estates, we found:
- Long before being appointed as bankruptcy trustee, a ‘line of credit’ finance arrangement was made in 2002 with a major bank to fund their business operations.
- The line of credit was secured over two properties.
- In 2006, the bankrupt sold one of the properties and the bank’s security was released on the sale.
- The bankrupt then borrowed from another bank to buy a new residential property.
- While it was intended that the bank’s security be ‘substituted’ over the new property, this did not occur, which the bank (now) claims was an oversight.
- Four years later, the bank appears to identify their ‘issue’ and attempted to fix it by trying to enter into a deed of priority with the prior ranking mortgagee. Understandably, this mortgagee wasn’t agreeable.
- The bank then wrote to the owner stating they no longer held security for the line of credit and “need to resolve this matter as soon as possible”. It subsequently became a secured loan in February 2014, when the owner of the property granted the bank a mortgage over the property.
- While the bank sought to secure their position, the bankrupt was in financial difficulty, primarily due to a significant debt owed to the Australian Taxation Office, which resulted in our appointment as their bankruptcy trustee.
Here lies the question.
Given the bank was an unsecured creditor until the execution of the mortgage agreement in February 2014, and the agreement was entered into for ‘no fresh consideration’—is the bank’s agreement voidable, resulting in the bankrupt estate claiming the surplus in the property free of any security interest?
We certainly thought so and the legal opinion we obtained agreed. Additionally, an abundance of case law on equitable mortgages could be drawn on for this case, for example, Swiss Bank Corp v Lloyds Bank Ltd  AC 584 and Pico Holdings Inc v Wave Vistas Pty Ltd  HCA 13 (just to name a few). Not surprisingly, the bank thought otherwise.
So considering the issues, relevant case law and the bank’s obvious lack of security, how did we resolve the matter?
After significant time and correspondence between all the parties, it was agreed that as trustees we would sell the property and pay the surplus into a trust account at settlement, and then begin negotiations to determine the division of funds . The property sold with over $300,000 in surplus, so there were certainly substantial funds to argue about.
However, after considering the potential costs, delays and uncertainty of pursuing litigation, it was resolved (commercially) to divide the surplus funds between the parties almost 50/50. Hence the bank received only a partial return on their purported security.
In summary, you could say it was ultimately a win-win. The bank walked away with some money, the bankrupt estate resolved the position commercially (without litigation), which allowed the bankrupt estate’s creditors to receive a dividend in a relatively short period.
However, the lesson is—had the bank obtained adequate security at the relevant time, the bankruptcy trustee would have had no claim and the bank would have received the full amount owing, rather than sharing funds with other creditors.