Restitution and illegality

By Legal Eagle

The High Court has just handed down a case dealing with the question of the availability of an action for money had and received when certain contracts have been found to be unenforceable as a result of illegality: see Equuscorp Pty Ltd v Haxton [2012] HCA 7.

Facts:

The facts of the case are rather complex, and involve a scheme for investors designed to maximise tax deductions. Heydon J gives a rather delightful summary of the transactions at [116]:

Those transactions are redolent of tax avoidance, suggest a preference for the beauty of the circle to the bluntness of the straight line, and indicate a single group of minds in control of superficially different entities. There is about them something of the night. However, it was not squarely suggested that the transactions were shams or that their somewhat murky atmosphere was relevant to the legal issues in these appeals.

I’m going to draw a diagram of the transactions involved in the scheme. Start at the blueberry farm square and work outwards. It may not surprise you to know that all of the entities involved in this transaction were controlled by the same people: brothers named Anthony and Francis Johnston.

 

The investors hoped that they would get an interest in a blueberry farm and its business, profits from the business, and a significant tax deduction which could be claimed against non-farming income. Because I’ve seen a a bunch of collapsed investment schemes in my time as a lawyer, my immediate thought on looking at this scheme was: If it sounds too good to be true, it is.

The important transaction for the purposes of this litigation is the loan transactions. The loan agreements varied from year to year. In each case, the investor was to make two initial repayments of capital at three and six months from the date of execution of the agreement. Most of the loans contained what is called a ‘non-recourse’ provision. This meant that if the investor made the initial payments of the loan, Rural’s right to repayment of the balance would be met only by recourse to the proceeds of fruit sales. The non-recourse provision only operated if the lender made the initial payments by the due date. The loan agreements authorised the buyer (Kathleen Drive Stone Fruit) to pay the proceeds of the sale of fruit to Rural. The security for the loans was a charge over each investor’s interest in the farm or the net proceeds of the farm. Each investor was required to execute a mortgage, charge or crop lien over their interest in the farm when requested to do so. Some of the loan agreements included an ‘acceleration provision’, which made the balance of the loan and interest immediately due and payable if the investor defaulted on payment of principal or interest.

Once the loan was made, Rural would draw an cheque on its bank account which was payable to the investor and represented the amount of the investor’s prepayment to Johnson Farm Management (JFM). The investors were directed to endorse the cheque in favour of JFM so as to perform his or her prepayment election. JFM then banked the cheque into Rural’s bank account. None of the investors involved in the proceedings gave Rural a mortgage. Most of the investors in the proceedings did not not make initial repayments on time, and thus, where there was a non-recourse provision, it was not triggered – instead the acceleration provision was triggered.

Shortly before the schemes collapsed in 1991, CBG granted Equuscorp a registered mortgage over the land containing the investors’ blueberry farms. Equuscorp then registered charges over the assets of CBG, JFM, Kathleen Drive Stone Fruit and Rural as security for a loan it advanced to companies in the Johnson group. None of the investors received any proceeds from the sales of fruit after 1 July 1991 and no repayments were made in reduction of the loans. Shortly thereafter, Equuscorp appointed receivers and managers to CBG, JFM, Kathleen Drive Stone Fruit and Rural pursuant to its powers to do so under the charges. In October 1995, Equuscorp sold the land on which the blueberry farms were situated as mortgagee in possession. Rural was wound up by a creditors’ resolution on 6 March 1996. On 16 May 1997, Rural sold the loan agreements between itself and the investors to Equuscorp – this involved Rural assigning its interests under the loan agreement to Equuscorp. Thus Equuscorp assumed the debts and the ability to recoup the moneys owing. The investors were given written notices of the assignment in November 1997. Between November 1997 and March 1998 Equuscorp commenced proceedings against the investors.

However, there was a problem for Equuscorp. The loan agreements turned out not to be enforceable because the scheme was illegal. Contrary to s 170(1) of the Companies Code then in operation in each investor’s home State, no prospectus, or valid prospectus, had been registered when the investors were offered what a “prescribed interest” within the meaning of s 170.

So Equuscorp was stuck. It had thought that by receiving an assignment of the debts it would be able to recover them from the investors, but now the agreements were void and unenforceable – in layman’s terms, they were not worth the paper they were written on.

Equuscorp thought that it might be able to recover the money via another means: the action for money had and received. The action for money had and received is a restitutionary action which arises when a defendant receives money from the plaintiff, but the consent to the transfer of money is somehow impaired, and the defendant would be unjustly enriched if he or she did not return it to the plaintiff. Equuscorp tried to assert that the particular factor which made the transfer unjust was  ‘illegality’ or alternatively,  ‘failure of consideration’ – that is, the very basis of the loan transactions had failed and accordingly, the lender (or the person now standing in the lender’s shoes) should be able to recover it.

There were three specific questions in this case:

(i) Could Rural have had a right to claim against the investors for money had and received notwithstanding the unenforceability of those agreements?

(ii) If Rural had a right to claim for money had and received, could that right could be assigned?

(iii) If the action for money had and received against each of the investors was assignable, was it validly assigned to Equuscorp under the assignment agreement?

The broader question to be addressed in this case is how contractual and restitutionary obligations should interact. It is clear that unjust enrichment is no longer to be regarded as a ‘quasi-contractual’ cause of action (see Deane J in Pavey & Matthews v Paul (1987) 162 CLR 221) but the precise delineations between contract and unjust enrichment still require exploration. Pavey & Matthews v Paul shows that even though a contract is void, a plaintiff may be able to recover a remedy in restitution where he could not do so under contract. In that case, a builder could recover payment for a house he had built for the defendant under a quantum meruit even though the contract was void because it was oral. But when does the fact that the contracts are void render it impossible for the plaintiffs to rely on a restitutionary action as well? It is also of interest because the Australian High Court has proved somewhat resistant to the advances of unjust enrichment law espoused by English scholars (particularly the late Peter Birks), and this case was expected to provide further insight into what the present High Court’s attitude to unjust enrichment law.

French CJ, Crennan and Kiefel JJ:

French CJ, Crennan and Kiefel JJ were unanimous in holding that restitution was entirely separate from contract, and they reiterated the High Court’s rejection of implied contract theory. They confirmed that unjust enrichment is an ‘organisational category separate from contract law’.

At [30] they had this to say about the role of restitution in Australian law:

Unjust enrichment therefore has a taxonomical function referring to categories of cases in which the law allows recovery by one person of a benefit retained by another. In that aspect, it does not found or reflect any “all-embracing theory of restitutionary rights and remedies”. It does not, however, exclude the emergence of novel occasions of unjust enrichment supporting claims for restitutionary relief. It has been said of Lord Mansfield’s judgment in Moses v Macferlan that it was his view that “the grounds for obtaining relief in money had and received were not to be considered static and the remedy could be made available in any case in which money had been paid in circumstances where it was unjust for the defendant to retain it.” Nor is the emergence of general principle precluded when “derived from judicial decisions upon particular instances”.

The question was then whether the plaintiff could rely on the action for money had and received notwithstanding the fact that the loan contracts had been void. French CJ, Crennan and Kiefel JJ said at [34]:

The outcome of a restitutionary claim for benefits received under a contract which is unenforceable for illegality, will depend upon whether it would be unjust for the recipient of a benefit under the contract to retain that benefit. There is no one-size-fits-all answer to the question of recoverability. As with the question of recoverability under a contract affected by illegality the outcome of the claim will depend upon the scope and purpose of the relevant statute. The central policy consideration at stake, as this Court said in Miller, is the coherence of the law. In that context it will be relevant that the statutory purpose is protective of a class of persons from whom the claimant seeks recovery. Also relevant will be the position of the claimant and whether it is an innocent party or involved in the illegality.

Interestingly (and hearteningly for me, at any rate) they cited Peter Birks with approval at [37]. Birks considered that where a contract was a loan contract, the enforcement of the contract and the action for money had and received produced “substantially the same performance”. Birks also considered that the relevant inquiry was whether allowing an action for money had and received would lead the law to self-stultification (ie. absurd contradicition).

Ultimately, French CJ, Crennan and Kiefel JJ decided that Rural would not have had a right to claim against the investors for money had and received had it discovered that the loan agreements were unenforceable. The reason for this was that Rural was not an arms length financier. Further the loan agreements were an integral part of the schemes, and insofar as they allowed investors to take up ‘prescribed interests’ without the benefit of the protections provided by the Companies Code, the loans encouraged and furthered the illegal purpose. The judges said at [45]:

Recovery from the investors would have been recovery from persons whose protection was the object of the statutory scheme. The respondents were not in pari delicto with Rural. The failure of consideration invoked by Equuscorp was the product of Rural’s own conduct in offering the loan agreements in furtherance of an illegal purpose. This is a clear case in which the coherence of the law, and the avoidance of stultification of the statutory purpose by the common law, lead to the conclusion that Rural did not have a right to claim recovery of money advanced under the loan agreements as money had and received.

In addition, even if there had been such a right, it had not been validly assigned by the agreement with Equuscorp, as the agreement dealt only with contractual rights under the deeds, not restitutionary rights.

Gummow and Bell JJ:

Gummow and Bell JJ also emphasised the separate natures of a contractual claim and a claim in restitution. They said at [101] that contractual and restitutionary issues could not be readily collapsed, and that merely because Equuscorp did not have a contractual remedy, this did not deny them an action for money had and received. They noted that in David Securities Pty Ltd v Commonwealth Bank of Australia (1992) 175 CLR 353, it was said the existence of “illegality” might give rise to a restitutionary action, but the court had to establish first whether the existing distribution of gains and losses should lie where they fall.

They noted that under the new US Restatement of the Law of Restitution and Unjust Enrichment states that a person who renders performance under an “illegal” agreement may not obtain restitution if the allowance of restitution will “defeat or frustrate the policy of the underlying prohibition” (§32(2)).

Sometimes recovery will be allowed for a plaintiff even if the statutory scheme renders the contract illegal because the statute was enacted for the benefit of a class including the plaintiff. However, in this case, the prospectus provisions were not enacted for the protection of Rural and the other companies, but for the protection of the investors in the prescribed interests. Accordingly, Rural could not have claimed an action for money had and received because it would have defeated or frustrated the policy of the prohibition, which was to protect persons such as the investors.

Gummow and Bell JJ had this to say about the basis of total failure of consideration:

Equuscorp sought to locate the appropriate “vitiating factor” for its restitutionary action not in “illegality” but in what was said to be “total failure of consideration” in the sense given that expression by Deane J in Muschinski v Dodds. His Honour there referred to cases:

where the substratum of a joint relationship or endeavour is removed without attributable blame and where the benefit of money or other property contributed by one party on the basis and for the purposes of the relationship or endeavour would otherwise be enjoyed by the other party in circumstances in which it was not specifically intended or specially provided that that other party should so enjoy it. (emphasis added)

The respondents correctly point out that the emphasised words distinguish the present situation from that in cases such as Roxborough v Rothmans of Pall Mall Australia Ltd, and would be fatal to the application of such a principle in these appeals. In truth, this consideration throws one back to the threshold issue of statutory interpretation, discussed above, which is determinative of the appeals.

So Equuscorp was tainted with Rural’s illegal conduct: the substratum of the relationship had been removed by Rural’s own illegal conduct, and Rural could never have mounted an action for money had and received.

Finally, they had this to say about the expression “counter-restitution”:

The term “counter-restitution” has been used in this Court but, without further analysis, is an unfortunate expression for several reasons. It is another expression, along with those recently disfavoured in Lumbers v W Cook Builders Pty Ltd (In liq) by Gummow, Hayne, Crennan and Kiefel JJ, which provides a framework for analysis at too high a level of abstraction. In the present litigation, the term, as pointed out above, distracts attention from the regular operation of established litigious procedures. It also distracts attention from a principled consideration of the question raised by McHugh and Gummow JJ in Fitzgerald v F J Leonhardt Pty Ltd. This, in short, is the degree of flexibility in fashioning the just measure of recovery on an action such as that for money had and received, given that, while it is a legal action not an equitable suit, it is settled in Australia that the action is a liberal action in the nature of a bill in equity. In the present litigation, for example, were Equuscorp to succeed, a question would arise as to the relevance and quantification of any offsetting “tax benefit” which the respondents had received before the investment scheme collapse.

Reminder to self: do not use the term ‘counter-restitution’ in front of Gummow J. I’ll call counter-restitution ‘set-off’ instead.

Heydon J (the dissent):

I’m getting used to the idea of Heydon J being the dissident. I rather expect it these days.

Heydon J found that the Companies Code did not prevent Rural from mounting an action for money had and received against the investors. He gave a number of reasons for this conclusion:

  • The Code did not expressly negate the possibility of an action for money had and received where the prospectus provisions had been breached. Nor did it impliedly do so.
  • To construe the statute as depriving Rural of its property rights would be extremely unjust.
  • The Code already provided for punishment for contravention of s 170(1).
  • The loan contracts were not essential to the profit-making aspect of the schemes, and to construe the Code as preventing an action for money had and received by Rural in relation to money advanced under a part of the schemes which was not logically integral to them was an extreme construction.
  • The unenforceability of the loan contracts did not necessarily mean that the action for money had and received was unavailable.

Heydon J held that there had been a failure of consideration being a failure of the state of affairs contemplated as a basis for the payments. Furthermore, Heydon J said there were nine reasons why it did not follow that it was unjust to let Rural have recourse to an action for money had and received to get the moneys back.

  1. Merely because the investors entered the investment schemes without the protection of an adequate prospectus does not explain why retention of the loan moneys was not unjust. It only explains why the loan contracts were unenforceable. The investors did not demonstrate how an adequate prospectus would have helped them or would have avoided the failure of the project.
  2. It did not matter that the repayments were to other companies within the Johnston group. This was irrelevant to why it was just to retain the money.
  3. It was true that the loans would not have been offered if it had been anticipated that the scheme was going to fail, but this does not explain why it was just to retain the money.
  4. Although the projects failed, they did not do so entirely or immediately, and the failure was causally unrelated to why the funds were advanced. The fact that the projects failed does not make it just  for the investors to retain the moneys.
  5. It was not true to say (as the Victorian Court of Appeal had said) that “the investors irrevocably lost their entire interest in the schemes pursuant to the enforcement of Rural’s (legally unenforceable) security interests”.
  6. It was not true to say (as the Victorian Court of Appeal had said) that the investors did not obtain taxation benefits from the scheme or that this was why they entered into the schemes.
  7. The investors could not have participated without the Rural loans unless they used their own funds or obtained an outside loan, and accordingly they benefited from them.
  8. The investors submitted that the benefits they received were not received at the expense of either Rural or Equuscorp. But even if this was so, it does not deal with the fact that the loans were real loans, and had to be so  in order to justify the tax deductions for the interest paid on them. From the loans the investors derived tax advantages and the right to participate in the schemes. The investors are essentially trying to resist repaying the loans from which they gained real advantages.
  9. Although Equuscorp only paid $500,000 for an assignment of the 638 loans with a face value of $52,584,005, this does not render the resistance of the respondents to repayment of the loans just.

Thus Rural could have mounted an action for money had and received against the investors.

Heydon J further held that the loans could have been assigned, and in fact, were assigned according to the terms of the assignment deed so that Equuscorp could have recourse to an action for money had and received.

Conclusion

The case is important as it delineates the relationship between contract and restitution in greater detail. While the unavailability of a remedy in contract because of illegality does not establish that a restitutionary remedy will be unavailable, the approach of the majority is to focus upon the precise intent and terms of the statutory prohibition which renders the contract void and ascertain whether this prohibition was also intended to negative a restitutionary action, and whether the law would be sufficiently “coherent” if a restitutionary remedy were allowed.

Actually (and this rather shocks me) at first  blush, I prefer Heydon J’s analysis, although perhaps I might change my mind if I think more deeply about it. Zounds, could it be so? Of course, I would have to look further into the nature of prospectus provisions such as those in the Code before I made up my mind entirely.

I also feel that this case represents a slight softening of the High Court towards restitution, and that makes me pleased. Just as it was perceived that there was an imperial march on the part of negligence into tort law and private law more generally, I think that some (such as Gummow J) felt that there was an imperial march on the part of restitution into Equity in particular.

The proper attitude of the court to the work of restitutionary scholars should be one of open-minded skepticism. In other words, I do not think that courts should close their minds wholly to a restitutionary analysis simply because it contains the fatal word ‘restitution’ or the name ‘Birks’, but I would not want courts to accept such analyses unquestioningly either. Sometimes I feel restitutionary solutions work better; but at other times, I believe that they do not, and we’re better off leaving a particular area of private law undisturbed. In any case, I am hopeful that the Court is getting closer to that ideal position.

17 Comments

  1. Posted March 12, 2012 at 2:14 pm | Permalink

    It seems to me that none of the parties appeared before the Court with “clean hands”.

    Would I be correct in saying this?

  2. kvd
    Posted March 12, 2012 at 2:53 pm | Permalink

    There is nothing wrong or even illegal with any part of the original scheme – if LE’s diagram is accurate.

    Me, I’d be pursuing any and all lawyers involved in allowing the situation to occur that the ultimate producing asset – the land – could be sold out from under the various parties – and I do understand that said owners of the land were themselves involved in the process.

    Also, please tell me this was not one of the many schemes seen in the pages of the Fin Review every May-June?

  3. kvd
    Posted March 12, 2012 at 4:16 pm | Permalink

    Some are likely to have relied on professional advisers (like Mr Haxton, who consulted Coopers & Lybrand). Some quite possibly knew about the legal requirement for prospectuses.

    LE, if you ever suggest Heydon J has no sense of humor, I shall refer you to this 😉

  4. Posted March 13, 2012 at 11:53 am | Permalink

    That’s confusing case. I’m glad you made a diagram!

    My initial reaction is to go with the majority. The loan was too closely related to the investment scheme in my mind, not to be considered part of the risk that was intended to be protected against through the code (by mandating the prospectus). Although, Heydon J does raise some interesting points that had me thinking for a bit.

  5. paul walter
    Posted March 13, 2012 at 3:22 pm | Permalink

    Ah my. I got a headache just trying to read it. Is it to do with pea and thimble?
    You must have to have a special sort of brain to do this.

  6. Davo
    Posted March 13, 2012 at 9:41 pm | Permalink

    Yer, well .. if an “investor” wants to throw ‘x’ dollars into a pokie machine …. why prevent them?

  7. Posted March 13, 2012 at 11:27 pm | Permalink

    um, ..am aware he some of the ‘comments’ i make are “off topic” but are vaguely related to “civic order” (long discussion in itself and not necessarily related to “law” – though both are interconnected)..

  8. Posted March 13, 2012 at 11:29 pm | Permalink

    * replace ‘he’ with “that” (damn you Autocorrect).

  9. Patrick
    Posted March 14, 2012 at 10:26 am | Permalink

    Heydon J is actually being cuter than you think, there was litigation some years ago in which Equuscorp investors did allege that their loan contracts were a sham and thus they didn’t have to pay up. They lost, thus Heydon J’s comment 😉

  10. Patrick
    Posted March 14, 2012 at 10:32 am | Permalink

    http://www.austlii.edu.au/au/cases/cth/HCA/2004/55.html

    Equuscorp Pty Ltd v Glengallan Investments [2004] HCA 55; 218 CLR 471; 211 ALR 101; 79 ALJR 206 (16 November 2004

  11. kvd
    Posted March 14, 2012 at 10:38 am | Permalink

    Hey Patrick, I’ll go read your [email protected] if you will kindly visit the Rinehart comments. Presence requested, and all that…

  12. Andrew Davies
    Posted March 14, 2012 at 5:25 pm | Permalink

    Saw this blog in a google search. Interesting analysis LE, and you have done a great job of unwinding a very complex set of transactions. Whilst my views will of course be influenced by my position (you can assume I’m disappointed) an interesting conclusion comes from our team’s review: would this Court have agreed with Pavey v Matthews at all? Under this Court’s approach, what consumer protection-focused legislation would ever allow a claim in restitution? It may not surprise you to hear I thought Justice Heydon got it right! This stands to substantially limit restitution in Australian law, on that basis not sure I agree it is a “softening” of their views.

    Andrew Davies, GM Equuscorp

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