Corporate Insolvency and Restructuring Forum 2 October Insolvent transactions Sections 588FF and 588FG of the Corporations Act

Transcription

1 Corporate Insolvency and Restructuring Forum 2 October 2002 Insolvent transactions Sections 588FF and 588FG of the Corporations Act Summary of statutory provisions The power of the Court to avoid insolvent transactions under s588ff Defences to insolvent transaction claims under s588fg Issues arising from the recent case law Andrew Boxall Partner Corporate Insolvency & Restructuring Simon Keizer Lawyer Corporate Insolvency & Restructuring saks S v Page 1

2 1. Introduction One of the fundamental principles of insolvency law is that, upon the liquidation of a company, all of the unsecured assets of the company should be collected and distributed to the unsecured creditors by the liquidator. Underlying this principle is the assumption that all unsecured creditors should be treated fairly and on a pro rata basis in the distribution of the unsecured assets of the company. Any payments which the company has made prior to its liquidation which favour or prefer one or more unsecured creditors over the general body of unsecured creditors offends this underlying assumption. It is for this reason that a legal regime exists which allows the liquidator of a company to seek to set aside such unfair preferences and similar transactions, and recover the proceeds for the benefit of the general body of unsecured creditors. The ability of a liquidator to set aside unfair preferences is governed by Part 5.7B Division 2 of the Corporations Act 2001 (the Act). The purpose of this paper is to examine the operation of two particular sections of the Division, s588ff and s588fg and, in particular, some issues that have arisen from recent judicial consideration of these sections. These sections contain the specific powers of the Court to set aside unfair preferences (s588ff), as well as the defences available to preferred creditors (s588fg). By way of introduction, and in order to place ss588ff and 588FG in context, this paper gives a brief overview of the interrelationship between various sections in the Division. The paper then goes on to review the operation of ss588ff and 588FG, as illustrated by cases that have recently come before the Courts. 2. Overview of the transactions that may be avoided by a liquidator Within Part 5.7B Division 2 of the Act ss588fa to 588FE provide for the types of transactions that may be avoided by a liquidator upon application to the Court. The aim of this section of the paper is to provide a brief overview of the types of transactions that may be avoided, by way of introduction to the specific sections considered in detail in this paper. The central provision in Part 5.7B Division 2 of the Act is s588fe. It sets out in broad terms the types of voidable transactions which may be set aside by the Court. In determining which transactions may be set aside by the Court, the section has regard to two separate elements: the nature of the transaction, and the time at which the transaction was entered into. The time frames in s588fe are defined in relation to the relation-back day. The determination of the relation-back day depends on the manner in which the company went into liquidation, and is set out in s9 of the Act. For instance, if liquidation occurs through a resolution of a creditor s meeting to appoint a liquidator, the relation-back day is the date on which the liquidator is appointed. However, if a company is already under a Deed of Company Arrangement when the company is wound-up, the relation-back day will be the date on which the Deed Administrator was appointed under the Deed of Company Arrangement. saks S v Page 2

3 Section 588FE provides that different types of transactions will be voidable in different time frames prior to the relation-back day. These time frames are set out below. (c) (d) (e) 6 months: a liquidator may avoid an insolvent transaction of the company that was entered into, or where an act was done for the purpose of giving effect to it, during the 6 months before the relation-back day or after the relation-back day but before the day when the winding up began (subsection 588FE(2)). 2 years: a liquidator may avoid an insolvent transaction of the company that is also an uncommercial transaction, that was entered into, or where an act was done for the purpose of giving effect to it, in the 2 years ending on the relation-back day (subsection 588FE(3)). 4 years: a liquidator may avoid an insolvent transaction of the company to which a related entity of the company is a party, that was entered into, or where an act was done for the purpose of giving effect to it, in the 4 years ending on the relation-back day (subsection 588FE(4)). 10 years: a liquidator may avoid an insolvent transaction of the company where the company became a party to the transaction for the purpose, or for purposes including the purpose, of defeating, delaying, or interfering with, the rights of any of its creditors on a winding up of the company, and the transaction was entered into, or where an act done was for the purpose of giving effect to the transaction, in the 10 years ending on the relation-back day (subsection 588FE(5)). No time limit: a liquidator may avoid an unfair loan to the company made at any time before the day when the winding up began (subsection 588FE(6)). Sections 588FA to 588FD then define the types of transactions contemplated by s588fe. An insolvent transaction is defined in s588fc as follows. A transaction of a company is an insolvent transaction of the company if, and only if, it is an unfair preference given by the company, or an uncommercial transaction of the company, and: any of the following happens at a time when the company is insolvent: (i) (ii) the transaction is entered into; or an act is done, or an omission is made, for the purpose of giving effect to the transaction; or the company becomes insolvent because of, or because of matters including: (i) (ii) entering into the transaction; or a person doing an act, or making an omission, for the purpose of giving effect to the transaction. Thus, in order to be an insolvent transaction that can be avoided by a liquidator, the transaction must either be an unfair preference or an uncommercial transaction. An unfair preference is in turn defined in s588fa(1). The section provides that: saks S v Page 3

4 A transaction is an unfair preference given by a company to a creditor of the company if, and only if: the company and the creditor are parties to the transaction (even if someone else is also a party); and the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company; even if the transaction is entered into, is given effect to, or is required to be given effect to, because of an order of an Australian Court or a direction by an agency. An uncommercial transaction is defined in s588fb(1), which provides that: A transaction of a company is an uncommercial transaction of the company if, and only if, it may be expected that a reasonable person in the company s circumstances would not have entered into the transaction, having regard to: (c) (d) the benefits (if any) to the company of entering into the transaction; and the detriment to the company of entering into the transaction; and the respective benefits to other parties to the transaction of entering into it; and any other relevant matter. 3. The power of the Court to avoid a transaction s588ff Once the Court has determined that a transaction is a voidable transaction pursuant to s588fe (that is, it is an insolvent transaction entered into during the relevant time period), its power to avoid that transaction arises under s588ff(1). Section 588FF(1) provides as follows. Where, on the application of a company s liquidator, a court is satisfied that a transaction of the company is voidable because of s588fe, the court may make one or more of the following orders: (c) (d) an order directing a person to pay to the company an amount equal to some or all of the money that the company has paid under the transaction; an order directing a person to transfer to the company property that the company has transferred under the transaction; an order requiring a person to pay to the company an amount that, in the court s opinion, fairly represents some or all of the benefits that the person has received because of the transaction; an order requiring a person to transfer to the company property that, in the court s opinion, fairly represents the application of either or both of the following: saks S v Page 4

5 (i) (ii) money that the company has paid under the transaction; proceeds of property that the company has transferred under the transaction; (e) (f) (g) (h) (i) (j) an order releasing or discharging, wholly or partly, a debt incurred, or a security or guarantee given, by the company under or in connection with the transaction; if the transaction is an unfair loan and such a debt, security or guarantee has been assigned an order directing a person to indemnify the company in respect of some or all of its liability to the assignee; an order providing for the extent to which, and the terms on which, a debt that arose under, or was released or discharged to any extent by or under, the transaction may be proved in a winding up of the company; an order declaring an agreement constituting, forming part of, or relating to, the transaction, or specified provisions of such an agreement, to have been void at and after the time when the agreement was made, or at and after a specified later time; an order varying such an agreement as specified in the order and, if the court thinks fit, declaring the agreement to have had effect, as so varied, at and after the time when the agreement was made, or at and after a specified later time; an order declaring such an agreement, or specified provisions of such an agreement, to be unenforceable. As can be seen, the Court has very wide powers under s588ff(1) to make an appropriate order avoiding the relevant transaction. Section 588FF(3) provides: An application under subsection (1) may only be made: within 3 years after the relation-back day; or within such longer period as the Court orders on an application under this paragraph made by the liquidator within those 3 years. Thus, a general limitation period of 3 years applies to applications by the liquidator of a company to avoid a voidable transaction. However, subsection (3) gives the Court a discretion to extend the period of time in which a liquidator may make such an application. 4. Issues arising from the recent cases on s588ff A number of issues in relation to the operation of s588ff have recently arisen in the cases. These include: to whom the proceeds are payable when a voidable transaction is set aside; whether a liquidator must sue each preferred creditor individually; how a liquidator can obtain an extension of the 3 year limitation period; and saks S v Page 5

6 whether the Court s power under s588ff is discretionary. Each of these issues are examined below. 4.1 When a voidable transaction is set aside, to whom are the proceeds payable? There have long been legislative provisions in Australia that have allowed a liquidator to set aside transactions that give an unfair preference to certain creditors. This is based on one of the fundamental policies of insolvency law, namely that the assets of the company should be distributed fairly and evenly among all of the company s unsecured creditors. The courts, therefore, have been given the power to set aside those transactions that unfairly prefer a particular creditor over the general body of unsecured creditors. The power to set aside unfair preferences is exercisable upon application by the liquidator to the Court. The traditional position in Australia is that where a liquidator makes such an application, he or she does so in a representative capacity on behalf of all the unsecured creditors of the company. The moneys recovered do not form part of the property of the company, but are instead held on trust by the liquidator for the benefit of the unsecured creditors of the company. The assets are therefore not available to satisfy the debts owed to a secured creditor of the company (see NA Kratzmann Pty Ltd v Tucker (1968) 42 ALJR 164 at 166). As discussed above, the current power of the Court to set aside an unfair preference is contained in s588ff of the Act. On the wording contained in s588ff(1), the Court is able to set aside a voidable transaction by making an order which requires the relevant moneys to be paid or property transferred to the company. Until recently, this precise wording has attracted little judicial comment. However, in Jonsson v Tim Ferrier Pty Ltd [2001] QSC 9, Jones J took the view that s588ff(1) enacted a substantive change to the law. In particular, His Honour stated (at 16) that: Section 588FF(1) would appear to make a change insofar as it directs monies recovered by the liquidators which have been subject to a voidable transaction becomes the property of the company. It would seem, though it is unnecessary to determine the point, that such funds would then be subject to any charge which a creditor would have over the company s assets. This is further supported by the fact that all the other forms of relief available under s588ff are to the benefit of the company. If this view is correct, any moneys or other property which the liquidator succeeds in recovering by having voidable transactions set aside will not pass directly to the liquidator to be held on trust for the unsecured creditors, but will instead become part of the property of the company, pursuant to the order of the Court. This property will then become available for the secured creditors of the company. Such a view of the effect of s588ff will, of course, be good news for secured creditors. However, it will also result in the voidable transactions regime of the Act failing to serve the very purpose for which it was enacted; namely, the principle that these transactions should be avoided in order to ensure that the entire body of unsecured creditors is treated fairly and equally. Instead of a avoiding a transaction with a preferred unsecured creditor for the benefit of the unsecured creditors as a whole, the liquidator and the Court will instead be saks S v Page 6

7 engaging in an exercise of avoiding such transactions for the benefit, first and foremost, of any secured creditors of the company who have not otherwise been able to fully satisfy the company s debt from the company s assets. When asked to consider the same submission in SJP Formwork (Aust) Pty Ltd v Deputy Commissioner of Taxation [2000] NSWSC 604, Santow J described this as a surprising and completely unheralded change to well established principles of bankruptcy law as applicable to companies (at 12). His Honour went on to say that [t]his radical change, if indeed it occurred, would have had to have taken place sub silentio. There has been no subsequent judicial consideration of Jones J s remarks in Jonsson v Tim Ferrier Pty Ltd, and in practice the courts have continued to make orders requiring voidable transactions to be set aside in favour of the liquidator of the company. Perhaps the solution to this issue is that put forward by Santow J in SJP Formwork. In that case His Honour felt that, even if the wording requires that the recovered preference be transferred to the company, this will be the company as controlled by its liquidator, and the liquidator will then apply the money received by the company for the benefit of the unsecured creditors. On this approach the payment will not be transferred to the company for the benefit of any chargee. 4.2 Can a liquidator commence proceedings against multiple preferred creditors in a single set of proceedings? Commencing a single proceeding against multiple preferred creditors - Dean- Willcocks v Air Transit International Pty Ltd Where a company has made a number of payments to creditors which a liquidator seeks to have set aside as voidable transactions, the liquidator would ordinarily commence separate proceedings against each creditor or in relation to each transaction. Such a procedure has obvious drawbacks, but various statutory and procedural provisions assist the liquidator in minimising the time and expense involved in pursuing each individual claim. These provisions include: the statutory presumptions contained in s588e of the Act, which provide for various things which have been proved in one recovery proceeding (such as that the company was insolvent at a particular date) to be presumed for the purposes of other proceedings in relation to the same company; and case management by the courts, by which the various proceedings are case managed together, with one proceeding selected for an initial hearing to determine various issues. However, an alternative approach was put forward in the recent case of Dean- Willcocks v Air Transit International Pty Ltd [2002] NSWSC 525. This case concerned the liquidation of 3 companies in the Austral Pacific group. As a group, the 3 companies carried on a substantial business of manufacturing and refurbishing buses. When the companies went into liquidation, the liquidator identified 58 suppliers and other creditors of the 3 companies that had been paid in the 6 months before the companies went into liquidation. The 58 creditors were distributed around Australia. Instead of commencing at least 58 separate saks S v Page 7

8 proceedings in order to recover these amounts as unfair preferences, the liquidator commenced a single proceeding, in which he and the 3 companies in liquidation were the plaintiffs and the 58 creditors were the defendants (the liquidator also commenced another proceeding against 13 separate defendants that received payments from the parent company of the 3 companies in liquidation). Commencing a single proceeding has obvious benefits to the liquidator, such as: (i) (ii) (iii) a substantial reduction in costs and time (for instance, in the preparation of pleadings and the payment of filing fees); ensuring that each of the claims is heard in the same court and case managed as part of the same process, regardless of the monetary amount involved or whether the preferred creditor is located interstate; and by having a single proceeding the findings of the Court in relation to insolvency will be binding in relation to all of the liquidator s claims, instead of merely being rebuttable presumptions pursuant to s588e of the Act. Why should the liquidator be allowed to proceed by way of a single proceeding? The issue that came before the Court was whether the liquidator was able to commence a single proceeding in relation to all of these separate transactions brought in relation to 3 different companies in liquidation. Pursuant to the rules of court, the various claims could be brought in a single proceeding if they arose out of the same series of transactions. Austin J held that this clearly was not the case each claim against each defendant arose from separate transactions entered into by the companies in liquidation. Despite this, Austin J held that he still had a general discretion under the rules of court to allow the liquidator to proceed by means of a single proceeding, and that he should exercise his discretion by allowing the liquidator to do so. Austin J noted the benefits which would accrue to the liquidator by commencing a single proceeding against multiple defendants. His Honour held that the liquidator is attempting to recover assets for the benefit of the unsecured creditors as a whole, and it is important in terms of public policy and the interests of the commercial community as a whole to allow the liquidator to adopt a process that is speedy, inexpensive and efficient. It was for this reason that Austin J was inclined to exercise his general discretion and allow the liquidator to maintain the single proceeding against the various defendants. (c) The arguments of the defendants The defendants put forward various reasons why they would be prejudiced if the liquidator was allowed to continue with a single proceeding. Some of the defendants argued that they would be prejudiced by being required to have their case heard in the Supreme Court instead of in a lower court, while other defendants, located interstate, argued they would be prejudiced by having the case heard in New South Wales. Austin J dismissed these arguments. Another argument put forward by the defendants was that the presence of 3 plaintiffs and numerous defendants would make the logistics of the proceeding saks S v Page 8

9 unwieldy and unnecessarily expensive for each of the defendants. Austin J felt that this was a much stronger argument, and expressed the view that if all 58 defendants were still a party to the proceeding he would be reluctant to allow the liquidator to proceed in this manner. However, by the time the Court handed down judgment only 16 of the 58 defendants were still active parties the liquidator had reached settlements with the various other defendants. Due to this reduction in the number of defendants, Austin J held that the potential prejudice arising from the unwieldy nature of the proceeding was much reduced, and should not stop him exercising his discretion in favour of the single proceeding. It was also argued that each of the defendants defences may raise different issues to be considered by the Court. Austin J accepted that this may be so, but he also observed that at the date of the judgment no defences had yet been filed. His Honour stated that, should the defences result in many different issues being raised before the Court, then the different claims could be severed from the main proceedings at a later date. The issue that most concerned Austin J was the fact that there were 3 separate plaintiffs, each of which entered into different transactions with various of the defendants. However, only a single bank account existed for the entire business, and all payments into this bank account were processed by one of the plaintiffs on behalf of the other two. This point was critical to Austin J allowing the liquidator to combine the claims of each of the 3 plaintiffs into a single proceeding. As His Honour was satisfied that none of the defendants would suffer prejudice to such an extent that it outweighed the benefits of allowing the liquidator to proceed by means of a single proceeding, Austin J exercised his discretion to allow the liquidator to do so. (d) The effect of the decision in Dean-Willcocks v Air Transit International Pty Ltd The decision in Dean-Willcocks v Air Transit International signals that, in certain circumstances, the Court will allow a liquidator to commence a single proceeding against multiple preferred creditors. As outlined above, this can have obvious benefits to the liquidator. However, Austin J s judgment also makes clear that the Court will not always allow the liquidator to follow such a procedure. If the proceedings are likely to be too unwieldy (as the original 58 defendants would almost inevitably have been), it is almost certain that the liquidator will not be allowed to proceed in this manner. What is not clear from the judgment, and what has emerged from the subsequent comment on this case, is the additional tactical advantages which may accrue to the liquidator by commencing a single proceeding against multiple defendants. As noted by Austin J, by the time judgment was handed down only 16 of the original 58 defendants were still active parties to the proceeding. The liquidator had managed to settle with the other 42 defendants. Apparently most of the defendants, many of whom were pursued for relatively small amounts, agreed to compromise with the liquidator. Although in an ordinary proceeding in a lower court these defendants may have decided to pursue their defence, when faced with saks S v Page 9

10 the significant additional costs of, firstly, an interlocutory battle over the legitimacy of the liquidator s actions and, secondly, a potentially long-running and complex proceeding in the Supreme Court involving claims against various other unrelated parties, the incentive to settle must have been so much the greater. Thus, by choosing to proceed in this manner the liquidator also gave himself stronger ammunition for pursuing settlement negotiations with defendants who might otherwise have chosen to fight on. 4.3 Under what circumstances will a liquidator be granted an extension of time to commence proceedings against preferred creditors? Extending the time limit for commencing proceedings general principles As noted above, s588ff(3) imposes a general 3 year limitation period from the relation-back day on actions by a liquidator to avoid voidable transactions pursuant to Part 5.7B Division 2 of the Act. However, the Court has the discretion under s588ff(3) to extend such a time limit. It should be noted that any application for an extension of time by the liquidator must also be made within those 3 years. In order to obtain an extension of time a liquidator is only required to satisfy a relatively low threshold test. The liquidator seeking an extension of time is generally required to: (i) (ii) (iii) give an explanation for the delay; give a preliminary review of the merits of the case or, where the liquidator is yet unable to do so, give an explanation of the grounds for inquiring into the matter (see Taylor v Woden Constructions Pty Ltd [1998] FCA 1228); and show that the case for granting an extension outweighs any prejudice that may be suffered by the preferred creditor. Recent developments the DML Resources litigation In seeking an extension of time pursuant to s588ff(3), liquidators frequently made the necessary application to the Court on an ex parte basis, particularly in situations where the liquidator sought a general extension of time to allow for further investigations, rather than an extension of time in relation to a specific transaction which the liquidator wished to avoid. In the DML Resources litigation the liquidators of DML Resources Pty Limited and DML Resources (WA) Pty Limited had spent a significant period of time investigating the affairs of the companies and seeking litigation funding in order to pursue various claims against preferred creditors. During this period the liquidators had sent letters of demand to a number of creditors, in which the liquidators asserted that the creditors had received unfair preferences and demanded that the creditors repay these amounts to the liquidators. By far the largest creditor to receive such a letter of demand was BP Australia Limited (BP) the liquidators sought to recover, in total, more than $5 million from BP. BP refused to refund the amounts it had received from DML. Over an extended course of correspondence saks S v Page 10

11 between the liquidators and BP, BP maintained that it had a legitimate defence to the liquidators claims, and it said that it would vigorously defend any claim against it. Although the liquidators felt they had a strong case against BP, they also believed that they did not yet have sufficient information to fully assess the strength of BP s defences. It was also apparent to the liquidators that some of the other creditors may have had legitimate defences, but further information was also required in relation to them. The liquidators therefore decided to hold a series of public examinations in order to gather more information, before making a decision as to whether to proceed with the various claims against these creditors. By this stage almost 3 years had expired since the commencement of the liquidation. The liquidators therefore applied to the New South Wales Supreme Court, on an ex parte basis, for a general extension of time pursuant to s588ff(3), in order to allow them further time for investigation. Austin J granted the extension of time to the liquidators. BP then applied to the Court to have this extension of time set aside. BP argued that it should have been given the opportunity to be heard before the Court gave the liquidators any extension of time. In Brown v DML Resources Pty Ltd (No 2) [2001] NSWSC 590 Austin J agreed with BP, and set aside the extension of time. Austin J held that, under the principles of natural justice, BP had a right to be heard on the application to extend the time in which the liquidators could commence proceedings against BP, and the liquidators could therefore not seek the extension of time on an ex parte basis. His Honour stated that this did not require liquidators to give notice of their application under s588ff(3) to every person who has had dealings with the company during the relevant period, nor even to every creditor whose transaction with the company might be challenged as an unfair preference if the extension of time is given. In some cases, in my view, it will be justifiable for the Court to proceed without notice to the creditor, taking into account such factors as the size of the transaction, the extent of the communication between the liquidators and the creditor, the creditor s likely attitude to the liquidators claim, and the issues in dispute between them. (at 61) However, in the case of BP it was held that the liquidators believed they had a strong case against it, the amount of money involved was significant, and there had been significant correspondence between BP and the liquidators regarding the liquidators potential claim against BP. Austin J held that in these circumstances the liquidators should not be allowed an extension of time without BP first being given notice of the application and an opportunity to be heard on the application. As a result of this judgment the liquidators were faced with a situation where their extension of time had been set aside, yet by now the 3 year limitation period had expired, so they were unable to apply again for a further extension of time under s588ff(3). After a number of further judgments that clarified various issues in relation to commencing further proceedings (Brown v DML Resources Pty Ltd (No saks S v Page 11

12 3) [2001] NSWSC 719; Brown v DML Resources Pty Ltd (No 4) [2001] NSWSC 947; Brown v DML Resources Pty Ltd (No 5) [2001] NSWSC 973), the liquidators applied to the Court for an order under s1322(4)(d) of the Act. This section relevantly provides as follows. (4) the Court may, on application by any interested person, make all or any of the following orders, either unconditionally or subject to such conditions as the Court imposes: (d) an order extending the period for doing any act, matter or thing or instituting or taking any proceeding under this Act or in relation to a corporation (including an order extending a period where the period concerned ended before the application for the order was made) In Brown v DML Resources Pty Ltd (No 6) [2002] NSWSC 6 Austin J held that this provision allows the Court to extend the time in which a liquidator may commence proceedings to avoid a transaction under s588ff(1), or alternatively to extend the time in which a liquidator may seek an extension of time under s588ff(3), even if the liquidator applies to the Court after the 3 year period prescribed by s588ff(3) has expired. Austin J held that this was so even though there is case law suggesting the contrary (Star v National Australia Bank Ltd (1999) 30 ACSR 583, Tagoori Pty Ltd v Lee [1999] QSC 2591). On the facts of this case Austin J agreed to extend the period of time in which the liquidators could make an application to extend the time to commence proceedings against BP His Honour held that although the liquidators initial application for an extension of time was set aside as a result of a mistake by the liquidators (in not notifying BP of the application and thus giving BP an opportunity to be heard), this mistake was not an obvious or culpable one (at 89). The proceedings then went to a further hearing, in which the actual application to extend the time to commence proceedings against BP was considered and granted by Austin J (see Brown v DML Resources Pty Ltd (No 7) [2002] NSWSC 162). As a result of this series of decisions, liquidators will need to consider carefully whether it is appropriate to seek an extension of time by means of an ex parte application. A failure to notify likely preferred creditors against whom the liquidators may commence proceedings could result in the extension of time being set aside. The decision in Brown v DML Resources (No 6) means that all may not be lost if this occurs but, as that extensive (and expensive) sequence of litigation itself shows, it will be far preferable to avoid such complications in the first place. (c) Recent developments Extensions of time granted to deed administrator Subsequent to the decision in Brown v DML Resources (No 6), the use of s1322 of the Act again came into issue in Re Aura Commercial Interiors Pty Ltd [2002] NSWSC 380. In this case the company entered into a deed of company arrangement. Pursuant to the Act, the commencement of the deed of company arrangement was deemed to be the relation-back day for the purposes of setting aside unfair preferences. saks S v Page 12

13 The company continued under the deed of company arrangement for the entire 3 year period in which a liquidator could make an application to set aside unfair preferences pursuant to s588ff. However, as there was no liquidator during this time no proceedings were able to be commenced. Indeed, even an application for an extension of time was not able to be made, as s588ff(3) requires the application to be made by the liquidator of the company. The deed administrator, however, was of the opinion that there were unfair preferences which could be set aside should the creditors agree to wind up the company, and he did not want the right to set aside these unfair preferences to be lost. Barrett J, in the New South Wales Supreme Court, followed Austin J s view in Brown v DML Resources (No 6) as to the effects of s1322(4)(d), and agreed to make orders pursuant to that section extending the time in which proceedings could be commenced. In making this order Barrett J held that the deed administrator was an interested person within the meaning of s1322(4), and thus had standing to seek such an extension. 4.4 Is the court s power under s588ff discretionary? One further issue that has arisen from the recent cases on s588ff is the question of whether the Court s power to make orders pursuant to s588ff is a discretionary power. That is, once it has been demonstrated that a voidable transaction exists pursuant to s588fe, and there are no valid defences pursuant to s588fg, is the Court required to make an order avoiding the transaction, or does the Court nonetheless have a discretion not to make the orders sought? This issue arises due to the wording of s588ff(1). The subsection commences with the following words: Where, on the application of a company s liquidator, a court is satisfied that a transaction of the company is voidable because of s588fe, the court may make one or more of the following orders (emphasis added). This wording could be interpreted to mean, on the one hand, that the Court has a discretion whether to make any order at all. The alternative argument, of course, is that the Court must make an order, but the may simply gives the Court discretion to choose which of the various orders listed in the section is most appropriate. The argument that s588ff is a discretionary power has frequently been advanced in argument by defendants to a liquidator s action to recover an unfair preference. To date no Court has actually refused to make an order under s588ff when it is otherwise entitled to do so, and the argument that it is a discretionary power received no analysis in the cases. However, in the recent decision of Chesterman J of the Queensland Supreme Court in Sparks v Berry [2001] QSC 251, His Honour made the comment that Section 588FE(4) satisfied, there is a discretion granted under s588ff(c) to make an order that Mr Berry repay the benefit received. (at 16). On the facts of the case Chesterman J decided that the Court should exercise its discretion to make the order sought by the liquidator. There has been no subsequent judicial saks S v Page 13

14 consideration of this point. This case therefore raises the interesting question of whether the courts will accept the proposition that s588ff is a discretionary power, and if so how the courts will structure the use of their discretion. 5. Defences to voidable transactions s588fg 5.1 The defences available under s588fg If the Court finds that a transaction is voidable pursuant to s588fe, the defences available to the preferred creditor are contained in s588fg. Section 588FG provides two sets of defences to an action by a liquidator to have a voidable transaction set aside. The availability of these defences depends on whether the person against whom the liquidator has brought the claim was a party to the voidable transaction. 5.2 Defence for a party to the voidable transaction If the person against whom the liquidator is proceeding was a party to the voidable transaction, they may have recourse to the defence in s588fg(2). The section provides as follows. A court is not to make under s588ff an order materially prejudicing a right or interest of a person if the transaction is not an unfair loan to the company and it is proved that: the person became a party to the transaction in good faith; and at the time when the person became such a party: (i) (ii) the person had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent as mentioned in paragraph 588FC; and a reasonable person in the person s circumstances would have had no such grounds for so suspecting; and (c) the person has provided valuable consideration under the transaction or has changed his, her or its position in reliance on the transaction. Thus, in order for a party to the voidable transaction to make out a defence under s588fg(2), they must demonstrate 4 elements: they became a party to the transaction in good faith; they had no reasonable grounds for suspecting the company was insolvent or would become insolvent, at the time they entered into the transaction; a reasonable person in those circumstances would not so suspect; and they provided valuable consideration for, or changed their position in reliance on, the transaction. saks S v Page 14

15 5.3 Defences for a third party If the person against whom the liquidator is proceeding was not a party to the voidable transaction, then the defences in s588fg(1) apply. The section provides as follows. A court is not to make under s588ff an order materially prejudicing a right or interest of a person other than a party to the transaction if it is proved that: the person received no benefit because of the transaction; or in relation to each benefit that the person received because of the transaction: (i) (ii) the person received the benefit in good faith; and at the time when the person received the benefit: (A) (B) the person had no reasonable grounds for suspecting the company was insolvent at that time or would become insolvent as mentioned in paragraph 588FC; and a reasonable person in the person s circumstances would have had no such grounds for so suspecting. Section 588FG(2) thus creates 2 distinct defences for a third party. Firstly, if the third party did not receive any benefit as a result of the transaction, this is of itself a defence to an action by a liquidator to recover the proceeds of the voidable transaction. However, if the third party did receive a benefit (as will be the case in the vast majority of situations that fall within s588fg(1)), then the third party must demonstrate 3 elements: they received the benefit in good faith; they had no reasonable grounds for suspecting the company was insolvent or would become insolvent, at the time they received the benefit; and a reasonable person in those circumstances would not so suspect. It should be noted that very few of the decided cases actually concern the defences available to a third party pursuant to s588fg(1). This is because, as a matter of practicality, it is unlikely that a liquidator will pursue a third party in relation to a voidable transaction when it able to pursue a party to the transaction instead. 5.4 Differences between the defences Although the defences in s588fg(1) and s588fg(2) largely follow the same structure, there are three main differences between the two defences. Firstly, in order to obtain a defence under s588fg(2), a party to the voidable transaction must show that they provided valuable consideration, or changed their position as a result of entering into the transaction. There is no such requirement for third parties under s588fg(1). This difference is demonstrated by the case of Re Pacific Hardware Brokers (Qld) Pty Ltd (1997) 16 ACLC 442, in which the company in liquidation gave $30,000 to its sole director to buy a ring, which the director then gave to his fiancee. The Court found that the fiancee, who had no involvement with the company s business and no idea that the ring had been purchased with the company s money, was not a party to this saks S v Page 15

16 otherwise voidable transaction. She received the ring in good faith and did not have any grounds to suspect the company s insolvency, and she therefore succeeded in her defence under s588fg(1). However, had it been determined that she was a party to the transaction (for instance, if the company had made the payment to both the director and his fiancee, and they had together used this money to purchase the ring), then the fiancee would not have been able to claim a defence under s588fg(2), as she would not have provided any valuable consideration under the transaction (leaving aside, for the moment, the issue of whether she would have satisfied the requirement of good faith). Secondly, there is the issue of the relevant time at which to determine whether the person had reasonable grounds for suspecting the company s insolvency. If the person is a party to the transaction and is relying on the defence in s588fg(2), this is determined at the time the person became a party to the transaction, regardless of when the person received the actual benefit of the transaction. On the other hand, for a third party relying on the defence in s588fg(1), this is determined at the time the party actually received the benefit of the transaction. Thirdly, the defence available to parties to transactions does not apply to situations where the transaction is an unfair loan. There is no such restriction where the person is not a party to the transaction. 5.5 Basic principles governing the use of these defences The case law has established a number of basic principles governing the use of the defences in s588fg. Firstly, the onus of proving the defence rests with the person claiming the defence (Levi v Guerlini (1997) 24 ACSR 159; 15 ACLC 913). The requirement of good faith, which is common to the defences under both s588fg(1) and s588fg(2), is to be given its natural meaning (Re Ermayne Pty Ltd (1999) 30 ACSR 330; Sutherland v Eurolinx Pty Ltd [2001] NSWSC 230), and is a subjective test (Downey v Aira Pty Ltd (1996) 14 ACLC 1068). That is, the person must have acted honestly and with propriety in entering into the transaction or receiving the benefit for instance, acting without an expectation that the person is being preferred over other creditors (Smith v Deputy Commissioner of Taxation (1997) 23 ACSR 611; 15 ACLC 687). However, the largest body of case law, and the aspect of the defences that has attracted most judicial consideration, concerns the question of suspicion of insolvency. The classic formulation of suspicion is found in the High Court case of Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266, in which Kitto J said (at 303): A suspicion that something exists is more than a mere idle wondering whether it exists or not; it is a positive feeling of actual apprehension or mistrust, amounting to a slight opinion, but without sufficient evidence, as Chambers Dictionary expresses it. Consequently, a reason to suspect a fact exists is more than a reason to consider or look into the possibility of its existence. This formulation is uncontroversial, and has been consistently applied in the cases on s588fg. It is the issue of what factual circumstances are sufficient to give rise to such a saks S v Page 16

17 suspicion that has exercised the minds of the courts in many of the cases on s588fg. The recent decisions on this issue are explored further below. 6. Some issues in relation to s588fg 6.1 Suspicion of insolvency As mentioned above, the question of suspicion of insolvency is one of the most common issues to arise in the cases in relation to s588fg. Frequently the ability of a defendant to successful mount a defence under s588fg will turn on whether the defendant had reasonable grounds for suspecting that the company was insolvent. Each case will, naturally enough, turn on its individual facts. A fact scenario which in one case could give rise to a suspicion of insolvency, such as slow payment of invoices or the use of post-dated cheques, may not give rise to a suspicion of insolvency in other cases where such a practice was standard within the industry or in the business relationship of the parties. Similarly, a number of factors which in and of themselves may not be sufficient to give rise to a suspicion of insolvency may give rise to a suspicion of insolvency when combined together. There have been a number of recent cases which shed further light on when a certain fact scenario may give rise to a suspicion of insolvency. Sutherland v Eurolinx Pty Ltd In Sutherland v Eurolinx Pty Ltd [2001] NSWSC 230 the company in liquidation, Sydney Appliances, was a kitchen equipment retailer, and the creditor that had received unfair preferences, Eurolinx, was an importer and wholesaler of kitchen equipment. It was clear that Eurolinx had received unfair preferences from Sydney Appliances, and the main issue before the Court was whether Eurolinx, as part of its defence under s588fg(2), had reasonable grounds for suspecting that Sydney Appliances was insolvent. Pursuant to the terms of the supply contracts Sydney Appliances was required to pay Eurolinx within 30 days, although Sydney Appliances had a history of being late in its payments. However, in November 1996 Sydney Appliances informed Eurolinx that it was experiencing some financial difficulty and it would need the assistance of all of its suppliers in order to survive. It was therefore agreed to extend Sydney Appliances terms to 60 days, but only an informal basis. Although Sydney Appliances attempted to keep to the new 60 day terms, various invoices were paid substantially later than 60 days. In addition, Sydney Appliances had on occasions in the past sent undated or postdated cheques to Eurolinx, with instructions not to bank them until instructed to do so by Sydney Appliances. The frequency of this practice increased noticeably from about December 1996 onwards. However, none of the undated or post-dated cheques were dishonoured when banked by Eurolinx. Santow J held that Eurolinx should have reasonably suspected that Sydney Appliances was insolvent in these circumstances. His Honour stated that, although saks S v Page 17

18 each of these factors do not necessarily, in and of themselves, indicate that Sydney Appliances was insolvent, when taken together they did or should have led Eurolinx to a reasonable suspicion that Sydney Appliances was insolvent. In the judgment Santow J gives a useful summary of the principles that govern the question of suspicion of insolvency. His Honour stated (at 43-47) that: (i) (ii) (iii) (iv) (v) there is no single factor whose presence invariably establishes that there is or should have been a reasonable suspicion of insolvency; each of the factors should be looked at through the contemporary eyes of the parties, and not in hindsight; each factor should be considered in light of the general commercial circumstances prevailing between the parties and the commercial reality of the particular industry; one must consider the cumulative impact of each factor that was apparent to the preferred creditor; and undue weight should not be placed on late payment, as debts aren t always paid on time by solvent persons. Rennie v Printbase Pty Ltd In Rennie v Printbase Pty Ltd [2001] NSWSC 78 the company in liquidation, SL Electronics, was contracted by the Federal Government to provide services to the ANZAC frigate project. SL Electronics in turn subcontracted with Printbase to provide certain consultancy services as part of the project. Throughout the history of the relationship between the two companies there was a chronic late payment of invoices by SL Electronics. For the first 2 years of the relationship, from 1992 to 1994, payments were made by SL Electronics on average 62 days after invoices were rendered. For the period in which the liquidator sought to have payments set aside, December 1995 to June 1996, the average payment period was 51 days. No cheques were ever post-dated or dishonoured. Printbase was aware that the ANZAC frigate project was worth many millions of dollars to SL Electronics, and Printbase was also aware that SL Electronics had various other ongoing contracts. Indeed, Printbase was so confident in the financial position of SL Electronics that in March 1996 it purchased 20,000 shares in SL Electronics. However, in April 1996 SL Electronics informed Printbase that it was experiencing cash flow problems, and that it could only pay creditors amounts of less than $5,000, with all other payments being deferred. Later that month Printbase was informed by the director appointed to SL Electronics board by the National Australia Bank, a substantial creditor, that SL Electronics was experiencing short term problems and that it would take about 6 months to be trading profitably again. The Court held that the circumstances before April 1996 were not enough to give rise to a reasonable suspicion of insolvency. However, the combination of factors saks S v Page 18