Busted! Application For Orders Setting Aside Personal Insolvency Agreement Succeeds

In the case of Inspector-General in Bankruptcy v Hartnett [2025] FCA 111, the Federal Court considered whether a personal insolvency agreement (PIA) should be set aside on the basis that it was unreasonable, or not calculated to benefit creditors, under section 222 of the Bankruptcy Act 1966 (Cth) (Act).

The Chief Executive and Inspector-General in Bankruptcy (Inspector-General) of the Australian Financial Security Authority (AFSA) noted that this is the first time such an application has been considered by the Courts.

In this case the bankrupt used the votes of purported minority creditors to put up a PIA in order to both avoid bankruptcy and paying a larger genuine creditor.  In setting aside the PIA, the Federal Court considered whether the debts claimed by creditors, and their votes in favour of the PIA, were bona fide. 

Facts

The First Respondent, Mr Hartnett, was a former solicitor and principal of a law firm. Mr Hartnett had recently ceased practising following his involvement in the exorbitant charging of legal fees. This conduct resulted in a judgment debt owed by Mr Hartnett to Mr Bell.

After pursuing Mr Hartnett for the amounts owing to him, in December of 2023, Mr Bell served a bankruptcy notice on Mr Hartnett for judgment debts totalling $349,006.

In January 2024, Mr Bell filed a creditors petition. Mr Hartnett subsequently appointed controlling trustees, allowing the trustees to take control of his property and affairs without sequestering his estate.

Following appointment of the controlling trustees, Mr Hartnett provided a statement of affairs and a draft PIA to the controlling trustees. The following creditors were identified:

• Hartnett Service Trust (HS Trust) - owed $3.7 million;
• Mr Bell - owed $584,500;
• Walsh Accountants - owed $1,600;
• MPB Investments Pty Ltd (MPB Investments) - owed $550; and
• Henry House & Home - owed $1500.

In March 2024, the controlling trustees issued an initial notice to creditors. Subsequently, a further creditor, Arawak Holdings Pty Ltd (Arawak), lodged a statement of claim in the amount of $144,000.

For the PIA to be adopted, it was necessary for the PIA to be accepted by a majority of the creditors and at least 75% in value of the creditors.  

In this instance, the PIA was successfully carried in number due to the three minor creditors, each with debts less than $2000.  The PIA was also carried in value because of a related-party creditor, being the HS Trust, controlled by Mr Hartnett’s wife.  The HS Trust was owed 83% of Mr Hartnett’s total debt but was not set to obtain a dividend under the PIA.  The only two significant creditors who were arms-length from the debtor, Mr Bell and Arawak, voted against the PIA.

The PIA offered a negligible return to creditors of $15,850 (after expenses), as against the total debt of $4,450,980. This resulted in an estimated return to creditors (other than the HS Trust) of 2 cents in the dollar.

The Inspector-General and Mr Bell each sought to set aside the PIA.

Statutory provisions

Section 222(1) of the Act provides that a PIA may be set aside by the Court upon the Inspector-General’s application if:

• the terms of the PIA are unreasonable, or not calculated to benefit creditors, per section 222(1)(d); or
• the Court is satisfied that the PIA ought to be set aside for any other reason, per section 222(1)(e).

The Court summarised the following relevant factors when determining an application under section 222(1)(d):

• the relative size of debts owing and the return to creditors under the PIA;
• the nature of the relationship between the debtor and the creditors who voted in favour of the PIA;
• whether the circumstances call for a greater opportunity to inquire into the debtor’s affairs and the closeness of the creditors’ votes, particularly if some creditors were not at arm’s length from the debtor; and
• the inadequacy of a return, especially so when other factors point in favour of setting aside the PIA.

Further, the Court has a broad discretion under section 222(1)(e) to set aside a PIA if it is appropriate to do so for any other reason.

Decision

The Court made orders setting aside the PIA on the grounds that it was unreasonable, and not calculated to benefit creditors, pursuant to s 222(1)(d), and that there were other reasons why it should be set aside pursuant to s 222(1)(e)¹:

The following factors were considered, which favoured a determination that the PIA should be set aside:

• The dividend to creditors under the PIA was “trivial” in comparison to the total amount owing to creditors.  The Judge held that the disproportionate return against the total volume of debts would have been better dealt with by way of bankruptcy, and that a bankruptcy would provide for the proper inquisitorial and investigative functions to be undertaken²: 
• There was a serious question as to whether the debt claimed by the related party, namely the HS Trust, was a bona fide one, either in the amount claimed or at all, given:
  • Mr Hartnett’s wife was a director of the HS Trust when it entered into the PIA. She submitted documents to the controlling trustees on behalf of the HS Trust and caused the HS Trust to cast a decisive vote; and
  • the motive for the HS Trust to vote was to avoid Mr Hartnett’s bankruptcy for personal reasons, and such motive is unconnected to the prospect of a financial return to the HS Trust in its capacity as a creditor³: 

Section 222(1)(d) speaks on ‘the benefit to creditors of a PIA’, which does not extend to benefit the interests arising from familial relationships, friendships or emotional attachments. 

There were serious concerns about the validity of the debts claimed by the minor creditors and Mr Hartnett’s conduct relating to them in the lead up to the PIA being entered into. In investigating the claims of the minor creditors, the Court held:

• Mr Hartnett had prepared statement of claims and proxy forms for all of the minor creditors, which included a direction to vote for the PIA.
• There was a question as to whether Henry House & Home was a creditor at all, because the claim had the “hallmarks of a sham”.
• Mr Hartnett had requested Walsh Accountants to reissue an invoice, amended to include his own name, that was originally only addressed to the HS Trust.
• Mr Hartnett caused MPB Investments to issue an invoice for the purpose of gathering friendly creditors and that there was a serious question concerning the validity of that invoice. 

In summary, the votes of the minor creditors in favour of the PIA were each obtained by Mr Hartnett for the purpose of both avoiding bankruptcy and paying the debt owed by him to Mr Bell.  The Judge held that this conduct constituted an abuse of the process under the Act, which is a compelling reason to set aside the PIA.

Mr Hartnett argued that setting aside the PIA would be prejudicial on the basis that the transactions contemplated by the PIA had been completed. In rejecting that argument the Judge held that, although this is a relevant factor against setting aside the PIA, it does not overcome the more compelling factors which favour setting aside the PIA.

Ultimately, orders were made that the estate of Mr Hartnett be sequestrated pursuant to section 222(10) of the Act and placed into bankruptcy.

Lavan Observations

This case serves as a useful reminder that the corporate regulator, AFSA, and the Inspector-General, may step in where there has been a misuse of a PIA to avoid bankruptcy and the paying of genuine creditors. 

A key takeaway from the decision is that in applications of this nature, the Court can and will look behind the creditor claims to determine whether they are bona fide, especially where the deciding creditors may be seeking to advance interests arising from familial relationships, friendships or emotional attachments.

If you have any questions about this decision, or in relation to a PIA, the experienced Lavan team is available to help.

Thank you to Kelsey Quick, Solicitor, for her valuable research and assistance with this article.