Failed asset protection

Notwithstanding that a promissory note is a relatively simple instrument, it may be drawn incorrectly. Examples of this are Re Permewan26 and Turner v O’Bryan-Turner, 27 both of which involved a “gift and loan back” scheme. A further analysis of these cases is set out in the paper “Keeping it in the family” by David Marks KC.28 However, the present article focuses on the issues raised by the promissory note and whether payment was effected.

Re Permewan

The facts of Re Permewan are as follows:
• 17 months before her death, the deceased made a statutory declaration that she intended that certain payments by her, including those by a bearer promissory note to the trustee of the Lotus Trust, were to be “by way of gift”;
• on the same day, the deceased signed a “bearer promissory note” under which she promised to pay the bearer the sum of $3m;
• on the same day, but this time on behalf of the trustee of the Lotus Trust, the deceased signed a receipt “as a gift”;
• thus far, the deceased has by promissory note promised to pay $3m to the bearer, being the trustee of the discretionary trust which has accepted the promissory note as a gift;
• also on that day, the deceased, as sole director of the trustee company, resolved:
• to note receipt of the bearer promissory note for $3m from herself by way of a gift of capital to the trustee to be held on trust;
• to acknowledge receipt of the bearer promissory note by execution of the bearer promissory note;
• to lend the money gifted by that bearer promissory note back to herself (ie in her personal capacity);
• that such loan be repayable on demand and secured by mortgage over real property acceptable to the trustee company; and
• to execute a loan agreement and mortgage security to effect the above resolutions;
• a loan agreement was signed that day between the deceased and the trustee of the Lotus Trust. The loan agreement referred to the trustee lending money to the deceased. It contained a covenant for provision of security over a nominated property, as and when required by the lender. The deceased was also to give on demand a security interest over shares in a company;
• it would seem that, on the same day, the deceased signed a “security deed” providing for a mortgage over the land and over the shares in question. A mortgage over the land was executed about a month later and was registered;
• also, on the critical day when all of the other documents (such as the bearer promissory note) were signed, the deceased gave a receipt in favour of the trustee as follows (referring to the promissory note):

“Received by Prudence Veronica Permewan on 18 April 2018 as a loan and cancelled by her because of the merger of the right to be paid and the obligation to pay.”

• Davis J describes the above as follows at para 24:

“24. By this series of extraordinary documents:

1. Prudence purports to gift, through the provision of the promissory note, $3 million to the Lotus Trust. This is despite the fact that Prudence clearly did not have $3 million in cash and would have to liquidate all of her assets to pay it.
2. The Lotus Trust has loaned $3 million to Prudence. This is despite the fact that the Lotus Trust clearly did not have $3 million in cash to loan to Prudence.
3. To secure the loan, so as to give effect to the gift evidenced by the promissory note, Prudence mortgaged or otherwise charged her assets.
4. The result of the transactions is that Prudence, who before these transactions had assets worth net $3 million, now has a debt of that amount to the Lotus Trust secured over her assets.”

• the applicant submitted that there should be an inquiry into the transactions, including that:

• the “promissory note” was not a promissory note as defined in the Bills of Exchange Act 1909. It thus did not have legal effect as a promissory note; and
• no gift had been perfected and that there was no consideration supporting a promise to pay. That is to say, no payment had been made.

Promissory note problems

There are a number of problems with the promissory note used in Re Permewan.

Note issues
In Re Permewan No. 2, the promissory note was described as follows:2

“30. The second document was headed ‘Bearer Promissory Note’ and contained three parts, each of which was signed by Prudence:

(a) a promise by Prudence to pay the bearer of the note the sum of $3 million;

(b) a receipt given by Zalerina as trustee of the Lotus Trust recording it as having received the promissory note from Prudence as a gift;

(c) a further receipt given by Prudence recording her as having received the promissory note back from Zalerina as a loan and the note having been cancelled by her because of the merger of the right to be paid and the obligation to pay.”

A bearer promissory note is one that is not made to a specific person, but is instead payable to whoever bears the note.30 It does not extinguish on presentment, unlike a note made to a specified person. An old one-pound note backed by gold is an example of a bearer promissory note. These old one-pound notes do no extinguish when the reserve bank (the maker) holds them. The author cannot understand, from the facts presented, why the note was said to have extinguished, other than that it was confused with a note made to a specified person.

A promissory note is not lent; it is conveyed. A promissory note typically does not come back, nor is it intended to come back other than on presentment. Instead:

• there should have been a loan from the Lotus Trust to Prudence and the payment of the sum advanced under the loan should have been made by way of passing the bearer promissory note (or, if the note was a made to a specified person, ie the Lotus Trust, by indorsement from that person); or alternately
• there should have been an accord and satisfaction agreement between the parties whereby the Lotus Trust agrees not to present the note in return for Prudence accepting that she owes the Lotus Trust the sum of $3m on the loan terms;

How can the bearer promissory note contain three parts? A note is a single instrument, being on one page. Further pages (called “allonges”) can be added, but must be affixed to the note.

Future gifts

The statutory declaration that Prudence swore before her death provides:

“14. It is my intention that all payments whether in cash, by cheque or Bearer Promissory Notes or otherwise, that I make from myself to the trustee of the Lotus Trust being a trust constituted by Deed dated 14 February 2011 are by way of gift unless otherwise recorded in writing.”

This is problematic because future gifts do not bind the donor. A statement made today does not bind the conscience of the donor tomorrow. In order to effect a
future donation, there would need to be some consideration in order to bind the conscience of the donor. The phrase “unless otherwise recorded in writing” is problematic because it is concerned with the records of the wrong person. Accounting records cannot be a statement of intention of another person. Whatever is written in the records of the Lotus Trust is irrelevant to the intentions of Prudence.

For Prudence to perfect the gift of the promissory note, she should have written at the time that she intended for the note to be a gift.

Turner v O’Bryan-Turner

The facts of Turner v O’Bryan-Turner are as follows:

• the transactions in 2010 began with the establishment of two discretionary trusts as an element of asset protection planning. There was a concern about claims that might be made by Mr John Turner’s second wife;
• Ward CJ in Eq describes what happened:

“15. John signed what are described as two promissory notes in favour of the trustee of those trusts … those notes together totalling around $2.5 million (that being said to be around about 90% of the value of the Trundle Properties at the time) … John executed statutory declarations at that time to the effect that all payments by him by promissory notes to the trustee were by way of gift … [At] the time that the notes were signed, there was no amount specified in them and there was no fixed date for repayment.”

• Ward CJ in Eq continues:

“16. John and [the trustee company] then entered into loan agreements whereby [the trustee company] in effect lent to John the $2.5 million that John had just ‘gifted’ to [the trustee company] under the promissory notes; and those two loans were secured by way of unregistered (and unstamped) mortgages … John then proceeded to cancel those promissory notes. 17. The consequence of the 2010 Transaction … was that, unless disturbed, [the trustee company] thus had the benefit of security over the Trundle Properties and would, at some point in time, be able to obtain what was then estimated to be approximately 90% of the value of the Trundle Properties. The purpose of the 2010 Transaction was unashamedly to protect John’s farming assets from a potential claim by his then de facto, Wendy …”

Inchoate promissory notes

The promissory notes, when executed, contained no sum.
Ward CJ in Eq provides an interesting discussion on the matter:

“Authorisation to a stranger to execute terms of the note

355. With those observations in mind, I turn next to the question, adverted to above, whether the Bills of Exchange Act permits the maker of a note to authorise another to ‘fill in’, so to speak, those essential terms of the promissory note.

356. In my researches, I have been unable to locate any authority on this point (and, indeed, the parties have not referred me to any authority that is of assistance).

357. As an initial matter, I note that s 89(2) by its express terms provides that, ‘[a]n instrument in the form of a
note payable to maker’s order is not a note within the meaning of this section unless and until it is indorsed by the maker’.

358. This might tell toward a construction that the maker of a note cannot delegate or authorise another to execute a promissory note, or at least such execution will be ineffective until the note has been indorsed by the maker.

359. However, as a matter of statutory construction, and not least noting the terms of s 5 (see at [349] above), I do not see a basis for concluding that the legislative regime prohibits a maker of a note from delegating to another, or authorising an agent, to complete, or fill-in, essential terms of a promissory note, including delegating or authorising the act of indorsement itself. However, and that tentative view notwithstanding, there remains an issue, to my mind, as to the time by which such execution (and, as the case may be, indorsement) must be completed. It is convenient to deal with that under the third of the questions adumbrated above.

Retrospective validity?

360. Again, in my researches, I have been unable to locate any authority on point (and, again, the parties have not referred me to any authority that is of assistance).

361. Nevertheless, I note that s 90 of the Bills of Exchange Act provides:

90 Delivery necessary

A promissory note is inchoate and incomplete until delivery thereof to the payee or bearer.

362. To my mind, this provision tells toward a conclusion that a promissory note must be complete in its terms, whether executed personally by the maker or by a properly authorised agent, before delivery to the payee or bearer. This is, I think, also consistent with the authorities and principles that I have made reference to above. It is consistent with the legislative purposes (as to which, see the observations of Williams J that I have excerpted above).

363. It follows that, whether the promissory notes were here later filled in or indorsed (whether personally or otherwise), they remained invalid as promissory notes for the purposes of the Bills of Exchange Act.” (emphasis added) It is relevant to raise s 25 of the Bills of Exchange Act 1909, which provides as follows:

“Inchoate instruments

(1) Where a simple signature on a blank stamped paper stamped with an impress duty stamp is delivered by the signer in order that it may be converted into a bill, it operates as a prima facie authority to fill it up as a complete bill for any amount the stamp will cover, using the signature for that of the drawer or the acceptor or an indorser.

(2) And in like manner when a bill is wanting in any material particular, the person in possession of it has a prima facie authority to fill up the omission in any way he or she thinks fit.

(3) In order that any such instrument when completed may be enforceable against any person who became a party thereto prior to its completion, it must be filled up within a reasonable time, and strictly in accordance with the authority given. Reasonable time for this purpose is a question of fact:

Provided that, if any such instrument after completion is negotiated to a holder in due course, it shall be valid and effectual for all purposes in his or her hands, and he or she may enforce it as if it had been filled up within a reasonable time and strictly in accordance with the authority given.” (emphasis added)

Without the benefit of viewing the exact note used in Turner v O’Bryan-Turner, and reading only from the judgment, it seems that the missing attribute to the note was the authority to fill it up. Words to the effect of “this promissory note may be filled up to the sum of $2.5m” should have sufficed to ensure that it was clear on its face that it was valid once filled.

Without a valid promissory note to make payment, the loan behind the gift and loan back ultimately failed.

This Article Was Created By.

Adrian Cartland

Principal Solicitor at Cartland Law
Adrian Cartland, the 2017 Young Lawyer of the Year, has worked as a tax lawyer in top tier law firms as well as boutique tax practices. He has helped people overcome harsh tax laws, advised on and designed tax efficient transactions and structures, and has successfully resolved a number of difficult tax disputes against the ATO and against State Revenue departments. Adrian is known for his innovative advice and ideas and also for his entertaining and insightful professional speeches.