The Inspector-General in Bankruptcy has succeeded in having a debtor’s Part X personal insolvency agreement (PIA) of 1 March 2024 set aside pursuant to section 222(1) Bankruptcy Act on the basis that the terms of the agreement were “unreasonable or not calculated to benefit the creditors generally”. A sequestration/bankruptcy order was made by Justice Kylie Downes of the Federal Court against the debtor’s estate pursuant to section 222(10) on application by a creditor. Inspector-General in Bankruptcy v Hartnett [2025] FCA 111 (24 February 2025)
Despite AFSA’s array of real-time regulatory processes, the concerns about the PIA were drawn to its attention by a journalist, some several weeks after the PIA was approved.
Background
Briefly, the matter involved a Mr Hartnett, a former solicitor, who had been found to have engaged in exorbitant charging of legal fees, resulting in significant judgments against him. Part of his debt to the main creditor – Mr Bell – came from the decision in Bell v Hartnett Lawyers (No 3) [2022] NSWSC 1204 with Bell CJ saying at [131] that,
“[e]xorbitant charging debases the reputation of the legal profession as well as subjecting clients or others involved in litigation to unwarranted costs”.
On 22 December 2023, having been served with a bankruptcy notice from Mr Bell for over $304,000, Mr Hartnett
“sought pre-insolvency advice from SV Partners about a possible appointment under Part X of the Bankruptcy Act”.
On 24 January 2024, Mr Bell filed a creditor’s petition, which was listed for hearing on 5 March 2024. On 1 March 2024,
“Mr Hartnett appointed the Controlling Trustees, themselves officers of SV Partners”
under s 188 of the Bankruptcy Act and provided a statement of affairs and a draft proposal for dealing with his affairs under Part X. A report dated 28 March 2024 was sent to creditors for a 16 April creditors meeting.
That meeting was adjourned at the instigation of the trustee to allow further time to adjudicate and consider claims by creditors, to 18 April, and then adjourned again to allow further time for the controlling trustees to respond to questions raised by creditors, to 22 April 2024, with notices to creditors being provided each time.
The facts
The Judge said that the following facts were common ground:
(1) the PIA offered a negligible return to creditors of $15,850 (after expenses), as against total claimed debts of $4,450,980. That resulted in an estimated return to creditors (other than Hartnett Service Trust) of 2.165 cents in the dollar;
(2) the PIA was carried in value because of the vote of a related-party creditor (Hartnett Service Trust), which claimed some 83% of the total debts and which voted in favour of the PIA despite not receiving a dividend;
(3) the PIA was carried by number of votes because three minor creditors also voted for it, each with debts less than $2,000 in value (and therefore receiving estimated distributions under the PIA of between $11 and $38);
(4) Mr Hartnett prepared voting and proxy forms for these minor creditors;
(5) the only two significant creditors who were arms-length from the debtor voted against the PIA. Of the amount of $585,899.19 claimed by Mr Bell, a dividend of $12,686.59 was paid.
Not a great return
Mr Hartnett conceded that that the sum offered under the PIA was “not great” but that the return was “neither little [n]or trivial”. The Judge said that while the amount of the dividend is not a determinative factor, the dividend here was “so trivial or so disproportionate” that it is “better dealt with by way of bankruptcy” with “the Trustee in bankruptcy exercising relevant powers”: see Hingston v Westpac Banking Corporation (2012) 200 FCR 493; [2012] FCAFC 41 at [58].
The other circumstances of the case supported that view, such that,
“it is in both the creditors’ interests and the public interest that there be a proper investigation by a trustee in bankruptcy, exercising the suite of powers available in a period of a bankruptcy (including public examination powers)”.
Those circumstances included the conduct of Mr Hartnett during the hearing.[1]
Insufficient investigation
The Judge did not accept that there has been sufficient investigation into Mr Hartnett’s affairs and nor did she accept the opinion of the trustee that the return under the PIA was higher than any potential return in a bankruptcy. The trustee did not have all of the relevant information and,
“of that information which she did have, it came through Walsh Accountants, likely provided under the watchful eye of Mr Hartnett”.
Mr Hartnett had 16 private companies and 12 former companies, 13 trusts of which he was a beneficiary, and one unit trust of which he was a current director of the trustee company – a “supremely well-structured individual”.
The trustees had an investigation period of under four weeks between their appointment on 1 March 2024 and the creditors’ report on 28 March. The Court therefore placed “little weight’ on the trustees’ opinions in that report.
Abuse of process
The invoices of the minor creditors and their respective votes in favour of the PIA were each obtained by Mr Hartnett for the purpose of supporting the PIA and avoid paying the debt owed by him to Mr Bell. Such conduct constituted an abuse of process. That finding constituted another “compelling reason” to set aside the PIA.
New trustee’s fees
Another factor in favour of setting the PIA aside was that the nominated trustee said he was prepared to act as trustee of the bankruptcy “on a speculative basis”, such that the Judge was not prepared to accept “that the distribution to creditors in a bankruptcy would be nil”.
Lack of funds can be a reason for not setting a PIA or a Part 5.3A arrangement aside. There may be little point in putting a person into bankruptcy to allow a proper investigation by a trustee in bankruptcy, “exercising the suite of powers available including public examination powers”, if there are no funds to do so, despite the creditors’ interests and the public interest in doing so. Allowing a “spec” funding arrangement does address that somewhat, but it means that funds initially received by the trustee may go only to the trustee and any funder. This is an issue raised in the 2023 PJC Report on Corporate Insolvency.
An alternative, as AFSA advises, is that the Official Trustee itself could have administered the estate, this being one those that
“are either in the public interest or are uncommercial for private (registered) trustees …”.
In any event, the Court has here accepted the nominated trustee and it is assumed that there will be transparency about the final financial and regulatory outcome.
Comment
This PIA warranted being set aside and a sequestration order made. A “derisory” dividend is not necessarily fatal, but other adverse factors supported the decision made.
AFSA has noted that this is the first time the Inspector-General had made such an application to the court, which he describes as
“a clear and decisive example of intelligence-led regulation”.
The Inspector-General commenced his investigation on 4 June 2024 and he filed proceedings in the Federal Court on 26 August 2024.
AFSA’s regulatory processes
This matter came to AFSA’s attention not through its intelligence-led regulatory processes but from a “tip-off” by a journalist, and some months after the PIA was approved.
While AFSA has a system of monitoring and inspecting Part X agreements – for example those that pay a low dividend, ‘tip-offs’ are another perhaps lesser part of its regulatory process. Reporting a tip-off | Australian Financial Security Authority
In Monitoring and inspection of bankruptcy trustees and debt agreement administrators – Inspector-General Practice Statement 11 – AFSA refers to its focus on Part X agreements and that AFSA officers attend a sample of meetings of creditors in Part X matters. This provides AFSA with an opportunity to monitor and report on the standard of controlling trustees and trustee meeting practices and of monitoring debtors’ Part X proposals and addressing creditor queries and concerns.
A Part X trustee must file with AFSA all documents along the way – for example, the controlling trustee must give to the Official Receiver a copy of the draft PIA proposal (reg 61(3)) and the PIA proposal checklist, which is designed as an aid to the debtor and the controlling trustee in ensuring that the proposed PIA contains all the elements that are prescribed by the legislation.
AFSA says it examines these documents and if any queries or concerns are identified, it will discuss matters with the trustee and may attend the meeting.
Some debtor-specific criteria for attending a meeting are where the debtor’s creditors exceed $1 million and their proposal would provide an insignificant return, or AFSA has reason to suspect that full and true disclosure of information was not made.
In this case, the various documents would have been lodged throughout March and April 2024. It must have been a bit unusual that the 16 April 2024 creditors’ meeting was first adjourned at the instigation of the trustee to allow further time to adjudicate and consider claims by creditors, to 18 April, and then adjourned again to allow further time for the trustee to respond to questions raised by creditors, to 22 April 2024, with notices to creditors being provided each time.
Necessarily however, AFSA says it is not possible to attend all meetings and it must exercise its judgment as to which meetings are attended.
Trustees
In the context of “protecting against system misuse” AFSA says it is broadening its scope from pre-insolvency advice to include unethical and untrustworthy advice by trustees and debt agreement administrators, including deficient administration of personal insolvency agreements. Three of AFSA’s 12 active investigations relate to the potential misuse of personal insolvency agreements to protect some creditors over others. This includes the Harnett matter.
As to the trustees, while the Court made findings that aspects of their investigations were inadequate, it was not necessary to seek costs against them. However the trustees also sought certain positive findings (contained in a nine page table) and complained that a number of matters were not put to Ms Meagher as trustee under cross-examination. However, Justice Downes said that some of the findings sought were not pleaded and many of the findings either had no bearing on the orders sought or were contrary to findings which were made.
As to the pre-insolvency advice they gave to Mr Hartnett, the trustees would have filed a declaration of relationships, under s 189A, and the advice they gave may well have been no more than explaining the different personal insolvency options.
The future of Part Xs
Part X personal insolvency agreements were a precursor to Part 5.3A of the Corporations Act which presents similar issues. A difference is that the alternative to a PIA is to make the debtor a bankrupt for 3 years, which is a more extreme response than rejecting a DOCA and liquidating the company. As well, there is usually no real focus on continuation of the debtor’s business in the Part X case law, although a debtor ceases to be an ‘insolvent under administration’ (s 9 Corporations Act) once the terms of the PIA have been complied with, which could happen promptly, though the average period of administration is said to be 18 months.
PIAs are not frequent in number – never have been – perhaps because of the high voting threshold – only 233 personal insolvency agreement estates were finalized in 2023–24, of over 11,600 personal insolvencies.
Their average return in 2023-2024 was 8c/$, compared with bankruptcy at around 2c. Trustees’ fees totaled $3.4 million for dividends of $13.7 million paid.
Minimal returns
As to the minimal returns provided by some PIAs, AFSA gives an example of cautioning a trustee who agreed to a proposal by 2 debtors to pay creditors as little as 0.00005c in the dollar, under a section 73 composition. But even then, in Re Agushi [3]while the court agreed that the dividend return of 0.019c in the dollar was “comparatively modest” or even “derisory”, it noted that “it is but one consideration to be taken into account”, and that there will be circumstances
“where informed creditors may consider it in their best interests to approve a personal insolvency agreement and accept comparatively little in return”.
Similarly, in Re Emmett [4]the Judge commented that while dicta suggest that small dividends and substantial debts might be sufficient, without more, to set aside a composition,
“it is significant that no case has been found where that has happened”.
See also Moran v Robertson [2012] FCA 371.
Hint of abuse of process will change things, such as in one case where suggestions of tax evasion and sham transactions perhaps caused an otherwise generous 3 cents in the dollar to be assessed as “manifestly unreasonable and derisory”.[5]
Shocking?
Some time ago, last century, one experienced judge was stirred to exclaim, in relation to a Part X, that
“there is something which, if not shocking, is at least something which takes one aback about a suggestion that somebody who owes almost 5.5 million dollars can offer $15,000 and walk away without there being any appropriate investigation of his affairs”: Sheppard J, as quoted in the appeal decision Re Lancaster v NZI Capital and the Official Trustee in Bankruptcy [1991] FCA 471.
Given the limited returns in insolvency, the shock value today might be much reduced.
Finally
And interestingly, Justice Downes concluded by saying that in anticipation of an application by Mr Hartnett to stay the sequestration order pending any appeal, she “observe[d] that the Federal Court does not have that power”, referring to Ritson v Commissioner of Police (NSW) [2021] FCAFC 208 at [64]–[65].
And commendably, the Judge delivered her judgment promptly, on 24 February, following three days of hearing on 28–30 January 2025.
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[1] “82. Because of the manner in which Mr Hartnett gave his evidence under cross-examination (which gave me no confidence that his answers were correct) and because I consider that the vote in favour of the PIA was a contrived one for which he was responsible, as I address below, I do not accept any evidence given by Mr Hartnett in this proceeding (whether oral or written). In short, Mr Hartnett is not a reliable witness”.
The Judge went on to say that Mr Hartnett, “a solicitor with litigation experience” took home a folder of documents to which he was referred during his cross-examination. When his cross-examination continued the next day, he admitted this but claimed that he had not looked at the documents. The Judge did not accept this as being “objectively unbelievable”. This conduct only served to strengthen the Judge’s view that she could not accept any of his evidence.
[2] Section 204(1)(b) of the Bankruptcy Act; r 75-132(1) of the Insolvency Practice Rules (Bankruptcy) 2016.
[3] 1992] FCA 440
[4] [1991] FCA 632
[5] Stedman v Deputy Commissioner of Taxation [2000] FCA 336.
