Re Rodney Warren Hoffman; Ex Parte: Ivor Worrell v Gregory Rudolph Schilling and Heather Grace May Hoffman [1989] FCA 11 (3 February 1989)

FEDERAL COURT OF AUSTRALIA

Re: RODNEY WARREN HOFFMAN; EX PARTE: IVOR WORRELL
And: GREGORY RUDOLPH SCHILLING and HEATHER GRACE MAY HOFFMAN
No. QLD E 190 of 1985
Fraud

COURT

IN THE FEDERAL COURT OF AUSTRALIA
BANKRUPTCY DISTRICT OF THE SOUTHERN DISTRICT OF THE STATE OF QUEENSLAND
GENERAL DIVISION
Pincus J.(1)

CATCHWORDS

Fraud - rescission of contract - affirmation - whether knowledge of facts giving rise to right to rescind - whether knowledge of right to rescind necessary.

Bankruptcy Act 1966, s.134(4)

HEARING

BRISBANE
3:2:1989

Counsel for Applicant: Mr B D O'Donnell

Instructed by: Purvis Duncan

Counsel for Respondent (Schilling): Mr G H Brandis

Instructed by: Seymour Nulty

DECISION

This is an application on behalf of the trustee of the estate of Mr. Hoffman, who was made bankrupt on 25 March 1985. The applicant seeks directions under s.134(4) of the Bankruptcy Act 1966 in respect of "a matter arising in connexion with the administration of the estate", namely, whether a sum of $25,000.00 in the applicant's possession forms part of the property divisible among the creditors. The sum in question was paid by Mr. G.R. Schilling, one of the respondents to the application, under a contract for sale of an interest in a business. Mr. Schilling's case is that he is entitled to his money back, because Mr. Hoffman, one of the vendors, was bankrupt when the contract was negotiated.

2. In late April 1985, Mr. Schilling, who was then unemployed, was asked by Mr. Hoffman to work in a drilling business run by the latter. A few days later, Mr. Hoffman asked whether Mr. Schilling would be interested in buying a one-third interest in the business, telling Mr. Schilling that he (Mr. Hoffman) was in financial difficulty. That was apparently so, but Mr. Hoffman understated the position; as I have mentioned, he had been made bankrupt in the preceding month. It is difficult enough to find people to put money into a failing business and, as no doubt Mr. Hoffman appreciated, almost impossible to sell an interest in one known to be bankrupt.

3. Mr. Schilling approached a bank to obtain money to buy the interest offered by Mr. Hoffman, and a loan was made, guaranteed by Messrs. G. and R. Netz of Mundubbera. Under the contract, made on 1 May 1985, Mr. Hoffman and his wife (who apparently then jointly owned the business) agreed to sell a one-third interest in it for $25,000.00. That sum was payable "at the date of possession or as the Vendor may direct in writing". For the $25,000.00, Mr. Schilling was to obtain an interest in certain equipment which was under lease or hire purchase and also in goodwill. Clause 7 of the agreement provided as follows:-
"THE Vendor will remain in possession of the said

business jointly and as partner with the Purchaser
and shall sign and execute all documents and do
all acts and things reasonably required for
putting the Purchaser in full possession and
enjoyment of his share of the said business and
the premises and for otherwise performing this
agreement".

4. The proper inference seems to be that on 1 May 1985 Mr. and Mrs. Hoffman were partners in the business and the intention of the contract was that Mr. Schilling would come in as a third partner. Of course, at that date, the assets with which the vendors purported to deal were, as to Mr. Hoffman's interest, vested in the applicant, his trustee in bankruptcy.

5. The transaction is not saved by s.126(1) of the Act, concerning dealings with property acquired after bankruptcy. The case is simply one of a purported sale by a bankrupt (together with another) of property which was no longer (so far as the bankrupt's interest was concerned) vested in him, but in his trustee. For that reason alone Mr. Schilling had, on ascertaining the facts, a right to rescind, as a matter of contract. Further, I find that he was misled by Mr. Hoffman.

6. The point just mentioned requires some elaboration, for Mr. O'Donnell, who appeared for the trustee, suggested that there was no deceit. He said that Mr. Hoffman had no obligation to reveal his bankruptcy and failure to do so was not fraud. In my opinion, for Mr. Hoffman to explain his desire to sell Mr. Schilling an interest in the business as being due to financial difficulty was prima facie fraudulent; the truth was that he was bankrupt and what he said was "such a partial and fragmentary statement of fact, as that the withholding of that which is not stated makes that which is stated absolutely false": Peek v. Gurney (1873) LR 6 HL 377 at 403. Mr. Hoffman has given no evidence denying what was attributed to him by Mr. Schilling and, in that state of the evidence, a finding of deceit appears to me inescapable. Further, I must find that Mr. Hoffman's statement constituted an inducement to Mr. Schilling. Naive though he appears to me to be, I am satisfied that he would not have procured the $25,000.00 on the guarantee of the Messrs. Netz to enter into partnership if he had appreciated that Mr. Hoffman had gone bankrupt.

7. Another version of the inducement given in correspondence, is that Mr. Schilling was told the $25,000.00 was necessary to avoid bankruptcy. I prefer the account directly sworn to by Mr. Schilling, but even on that just mentioned a finding of deceit would follow.

8. It is not clear on the evidence precisely what happened to the purchase price, but when (as a result of a public examination in January 1986) the trustee become aware of the transaction, the money was still held in a trust account; it was paid to the trustee who, being uncertain as to its proper fate, has very properly come to this Court about the matter. It would seem evident enough from what has been said that, if there were nothing more in it, Mr. Schilling would be entitled to a return of the $25,000.00. However, it was contended by Mr. O'Donnell, who argued the case carefully on behalf of the trustee, that subsequent actions on the part of Mr. Schilling deprived him of his right to the return of the money and that is the nub of the case. For reasons which are discussed below, Mr. Schilling's strongest case is in fraud (rather than contract) and it is unnecessary to consider the question of rescission under the law of contract; if Mr. Schilling cannot succeed in fraud, he must fail.

9. After agreeing, as I have explained, to come in as a partner and paying the $25,000.00 which had been borrowed from the bank, Mr. Schilling did not act as if he were a partner. He simply worked in the business under Mr. Hoffman's directions. Nor did he receive any direct distribution of profits; what happened was that certain monthly sums which were due to the bank which had advanced the $25,000.00 were paid by Mr. Hoffman, presumably out of the returns of the business. Mr. Schilling took no part in the management of the business and received nothing from it other than the benefit of the repayments which I have mentioned; he was also kept by Mr. & Mrs. Hoffman. The repayments, according to Mr. Schilling, "started off at $400 a month and went to $430"; he told me that he did not know how much remained owing but it was "closer to $20,000, I would say".

10. After ascertaining the existence of the contract dated 1 May 1985 and taking legal advice, the trustee's solicitors wrote a letter to Mr. Schilling at the address of his parents; Mr. Schilling denied having received the letter although he resided at that address at the relevant date. However, I cannot, on this evidence, find that Mr. Schilling received the letter and it must be ignored. On the same date - 3 July 1986 - the trustee's solicitors wrote to Mrs. Hoffman about the transaction asking for her co-operation to achieve the result that "with further receipts of some $5,000.00-$6,000.00, a dividend of 100c in the dollar might be paid in the Bankrupt's estate". What she was asked to do, specifically, was to consent to the use of the $25,000.00 for the benefit of the creditors.

11. The advantage to Mrs. Hoffman in doing so - pointed out by the letter - was that a creditor of Mr. Hoffman was threatening bankruptcy proceedings against Mrs. Hoffman.

12. A few weeks later (on 28 July 1986) a letter was written to the trustee, signed by both Mrs. Hoffman and Mr. Schilling, agreeing to "the trustee to use the $25,000 in the administration of the estate on Mr. Hoffman's behalf...".

13. There is a dispute as to the circumstances in which Mr. Schilling's signature was obtained. Mr. Schilling says that, one morning when he was about to leave for work, Mrs. Hoffman told him to "sign this here so we can complete the Contract". Mrs. Hoffman, who was not called, has sworn an affidavit giving quite a different version. She claims that she told Mr. Schilling the precise purpose of the letter and that Mr. Schilling signed after that explanation and with due deliberation.

14. Particularly as I have not seen Mrs. Hoffman, the resolution of this conflict has presented some difficulty. An improbability about Mr. Schilling's version is that, while he claims not to have read the letter, he swears that the words "a bankrupt", which were in the letter as tendered, were not in the one he signed.

15. I do not find it necessary to determine precisely which version is correct. I am satisfied, however, that, when Mr. Schilling signed the letter, he appreciated that its purpose was to permit the use of the $25,000.00 by Mr. Worrell, the trustee. I am uncertain whether Mr. Schilling understood that the $25,000.00 was to be expended in the course of administration of Mr. Hoffman's bankrupt estate, but that does not matter, for I am satisfied that he understood that point two days later when, as I shall explain, Mr. Schilling went with Mr. and Mrs. Hoffman to see the trustee.

16. According to the trustee's affidavit, he was handed the letter just referred to on 30 July 1986, at his office. His recollection is that he asked Mr. Schilling whether or not he knew that Mr. Hoffman was a bankrupt and Mr. Schilling replied that he did. The trustee also asked (according to his recollection) whether Mr. Schilling agreed to the use of the $25,000.00 in administration of the bankrupt's estate, and Mr. Schilling said that he did.

17. Up to that point, I accept the trustee's recollection as substantially accurate, but he added:-

"I was satisfied that Mr Schilling understood the
nature of the transaction".

18. In cross-examination by Mr. Brandis, who appeared for Mr. Schilling, the trustee said in effect that, although he felt at the time that Mr. Schilling understood the consequences of what was being done, he (the trustee) did not explain them to him.

19. Mr. Schilling's evidence was that he saw a plaque outside the trustee's office indicating that "Worrell was a bankruptcy trustee" but had no recollection of the purpose of the meeting. I am satisfied that the account of the matter given by the trustee is substantially correct.

20. The trustee instructed solicitors to draw up a deed for signature by Mrs. Hoffman and Mr. Schilling, apparently to give effect to what had been agreed at the meeting of 30 July 1986, but about the same time Mr. Schilling had some communication from one of the guarantors which caused him to become concerned. He claims that this contact with the guarantor was the first occasion on which he appreciated that Mr. Hoffman was bankrupt, but I do not believe that. I am satisfied that he knew at an earlier time that Mr. Hoffman was bankrupt. It is my opinion that he took very little interest in what he regarded as the legalities of the matter until one of the guarantors managed to induce in him some awareness of the implications of what had occurred. As far as the guarantors were concerned, the likely result of what was proposed by the trustee was (and, no doubt, still is) a claim against them by the bank for the balance of the $25,000.00 due.

21. On 11 September 1986, solicitors wrote to the trustee on behalf of Mr. Schilling. The letter complained of misrepresent- ation but did not purport to rescind the agreement for sale; it merely asked that the $25,000.00 be held by the trustee, which it was. In November 1986, Mr. Schilling ceased to work in the business and no further repayments of the loan were made to the bank thereafter. About the same time, items of equipment referred to in the contract of sale were repossessed.

22. Looking at the matter broadly, then, the purchaser (Mr. Schilling) has, by using the borrowing power of the guarantors, paid $25,000.00 for an interest in the business after bankruptcy and got, for the money, very little. The question whether he is entitled to a refund of the moneys paid, however, depends on narrower considerations to which I now turn.
Affirmation

23. I have held, in accordance with the contentions advanced by Mr. O'Donnell on behalf of the trustee, that Mr. Schilling was aware at the time he spoke to the trustee on 30 July 1986 of Mr. Hoffman's bankruptcy. It does not appear to me, however, that proof of that awareness is enough to show that Mr. Schilling's consent to the use of the $25,000.00 constituted an affirmation. There is nothing to show that Mr. Schilling knew that the bankruptcy had occurred even before the contract was made - some 16 months before the joint letter to the trustee. It must be said against Mr. Schilling that, when he found out that Mr. Hoffman was bankrupt, it would have been prudent for him to make an inquiry as to whether Mr. Hoffman had been bankrupt from the outset - i.e., when he induced Mr. Schilling to enter into the contract. But, according to Greig and Davis, "The Law of Contract", at p.1257:-

"Even when the innocent party ought reasonably to
have realised that a substantial breach has been
committed, he does not have the requisite
knowledge for his conduct to constitute an
election..."

24. The case relied on by the learned authors, Panchaud Freres S.A. v. Etablissements General Grain Company (1970) 1 Lloyd's Rep 53, was, as the text indicates, a case of breach of contract, not misrepresentation. However, it appears to me to be authority for the proposition for which it is cited (p 57 of the report) and accords with a dictum in the South Australian Supreme Court: Drozd v. Vaskas (1960) SASR 88 at 95-6 per Reed J. I accept what the authors say as correctly stating the law, at least in fraud.

25. In the Panchaud Freres Case, there was held to be an affirmation on the ground of estoppel. There is, however, no sound basis for a finding of estoppel here, as the trustee did nothing to his detriment in consequence of Mr. Schilling's actions; it would be neither unfair nor unjust to allow a departure from Mr. Schilling's former stance at this stage: see Thompson v. Palmer [1933] HCA 61; (1933) 49 CLR 507 at 547, Dixon J.

26. In Sargent v. A.S.L. Developments Limited [1974] HCA 40; (1974) 131 CLR 634, there was an allegation of affirmation precluding rescission. Stephen J., at p 642, said:-

"The nature of the knowledge which an elector must
possess is a matter upon which the authorities are
somewhat at variance. An elector must at least
know of the facts which give rise to those legal
rights, as between which an election must be
made....The extent of knowledge of relevant facts
necessary for the doctrine of election to apply
has been described as 'full knowledge of the
material facts'..."

27. Although there was a difference of view there (see Turner v. Labafox International Pty.Ltd. in the same volume at p 660) as to whether the alleged affirmer must be aware of his right of rescission, it appears to me that, particularly in a misrepresentation case, there should not be held to be an affirmation without proof of knowledge of all the essential facts. That has not been shown: I am satisfied that, when Mr. Schilling agreed to the use of the $25,000.00 by the trustee in July 1986, he knew that Mr. Hoffman was then bankrupt, but I am not satisfied that he then knew that Mr. Hoffman had been bankrupt all along - i.e., since a time before the contract of 1 May 1985 was entered into between Messrs. Hoffman and Schilling. On the evidence, he appears to have become aware of the whole situation when he contacted solicitors late in 1986.

28. It is, of course, clear that Mr. Schilling's agreement to the use of the $25,000.00 by the trustee would, but for the lack of proof of the requisite knowledge of facts, have been an affirmation - an unequivocal indication that Mr. Schilling wished the contract to stand. The same cannot be said of his continuing to work in the business until November 1986, as mentioned above; the agreement said nothing as to whether and on what terms Mr. Schilling should work in the business.

29. Although it is strictly unnecessary to do so, it is desirable to come to a conclusion on the question of whether knowledge of a right to rescind is necessary. For one thing which is clear is that, had Mr. Schilling appreciated that he could, when the matter was raised with him in 1986, have insisted on return of the $25,000.00, he would not have acted as he did.

30. It is ordinarily so that parties' rights, insofar as they depend on states of mind, depend upon knowledge of the facts rather than the law. For example, payments made under a mistake of law do not, whereas those made under a mistake of fact do, give a prima facie right to repayment: Werrin v. The Commonwealth [1938] HCA 3; (1938) 59 CLR 150. What has been described as "the working hypothesis on which the rule of law rests in British democracy" (Iannella v. French [1968] HCA 14; (1968) 119 CLR 84 at 113) applies particularly in, but is not confined in its operation to, the criminal law: ibid. Particularly as to commercially unskilled people such as Mr. Schilling, adoption of a rule requiring knowledge of the right to rescind, as opposed to knowledge of the facts giving rise to that right, would make affirmation hard to prove; short of an admission that there was legal advice, it is not easy to see how affirmation could be shown, in a case of this sort.

31. The weighty authority of Sir Frederick Jordan C.J. in O'Connor v. S.P. Bray Limited (1936) 36 SR (NSW) 248 at 262-4 may be invoked in favour of the view that, in general, an election between alternatives may be shown without proof of "knowledge of the legal consequences of the facts and of the legal rights involved" (263). The case is discussed by Mason J. (as his Honour then was) in Sargent v. A.S.L. Developments Ltd. [1974] HCA 40; (1964) 131 CLR 634 at 657-8 where, after referring to the inconclusive treatment of O'Connor v. S.P. Bray Limited in Elder's Trustee and Executor Co. Ltd. v. Commonwealth Homes and Investment Co. Ltd. [1941] HCA 31; (1941) 65 CLR 603 at 617-8, his Honour accepted the proposition that:-

"...where rights are exercised in virtue of an
estate in property, or by virtue of a contract,
and the rights so exercised were such as would not
exist unless the estate or contract subsisted on
foot.... ...knowledge of the existence of the
alternative right, as distinct from knowledge of
the facts giving rise to the right, is not
essential to the making of a binding election".

32. I respectfully disagree with the view expressed by Greig and Davis (op.cit.) at pp 1257-8, that the law as laid down in the English Court of Appeal in Peyman v. Lanjani (1985) Ch 457 "represents the law in Australia as well". I prefer to follow the expression of opinion in Sargent's Case to which I have referred.

33. However, that is not the end of the matter, for there is direct authority, particularly in Coastal Estates Pty. Ltd. v. Melevende (1965) VR 433 that the rule is otherwise in cases of fraudulent misrepresentation. The case was discussed in Sargent's Case by Stephen J. without disapproval, but Mason J. expressly reserved his opinion as to its correctness, remarking that:-

"...it should be kept firmly in mind that the
doctrine of election is of general application and
that no good purpose is to be served by drawing
distinctions in its various applications unless
considerations of justice make it necessary or
expedient to do so". (658)

34. In using these expressions, perhaps his Honour had in mind not only the suggested distinction between election to rescind on account of (for example) breach of contract and rescission for fraud, but also the possibility of making the presence or absence of knowledge of the right itself, as opposed to the facts, relevant only where there is "less unequivocal conduct, only providing some evidence of an election": per Stephen J. at p 646.

35. In my respectful opinion, the question whether knowledge of the actual right to rescind is essential in fraud cases is still open, as was said in Sargent's Case (p 658). Although it is true that the authorities are at variance, the better view appears to be that (as was the case, in the opinion of Jordan C.J., in 1936) the weight of authority favours the existence of the general rule that, where knowledge is necessary to make an election effective, it is knowledge of the facts giving rise to the right to elect, not knowledge of the right itself, which must be proved. For a number of reasons I prefer to apply that principle, even in a fraud case: it accords with the general rule as to the relevance of knowledge of the law, it removes the necessity of an awkward examination, in many cases, of what legal advice has been received, it has the virtue of simplicity alluded to in the passage quoted from Sargent's Case at p 658 and, lastly, it does not altogether deprive the defrauded party of his remedy, as damages remain available.

36. In summary, if the law were that knowledge of the right to rescind is necessary, as opposed to knowledge of the facts giving rise to the right, I would hold in favour of Mr. Schilling on the ground that he had not the former knowledge at the relevant time; but, in my opinion, only the latter knowledge was necessary. On the basis explained above, I have concluded that he had not even the necessary factual knowledge.

37. A question which arises, but which I think inappropriate to decide, is whether the election to affirm is binding where there is no prejudice to the other party caused by the election: see as to election in contract (not fraud): Sargent's Case (above) at p 647 per Stephen J. and Turner v. Labafox International Pty. Ltd. [1974] HCA 41; (1974) 131 CLR 660 at 665 (Stephen J.) and 670.9 (Mason J), and see Khoury v. Government Insurance Office of New South Wales [1984] HCA 55; (1984) 58 ALJR 502 at 506.

38. An entirely separate ground upon which Mr. Brandis sought to establish a right in Mr. Schilling to the $25,000.00 was that a constructive trust arose out of the circumstances and nothing has occurred to bring it to an end. I do not propose to deal with these arguments - not because they are without substance but because it seems inappropriate to do so in view of the conclusions I have expressed above.

39. The remaining matter for consideration is what relief should be granted. There is no precise evidence as to how much has been paid off the debt; as one would expect, Mr. Schilling had only the haziest notion on that subject. The matter was argued, I think, on the assumption that either the trustee or Mr. Schilling would take the whole of the $25,000.00. As Alati v. Kruger [1955] HCA 64; (1955) 94 CLR 216 exemplifies, where precise restitutio in integrum is impossible, the court may be required to make fairly complex orders to restore the parties substantially to the status quo. During the time Mr. Schilling worked in the business, according to his evidence, he received his board and keep, in addition to which some payments were made off the debt due to the bank. It may be thought that a reasonable approach to justice would be achieved if it were ordered by way of rescission that only so much as is necessary to discharge the liability to the bank should be repaid, the rest remaining with the trustee applicant. However, I shall give counsel an opportunity to deal with that point - I hope, fairly summarily - and also to address me on costs.