Tectron Industries Pty Ltd v Taylor

[2006] SASC 175

SUPREME COURT OF SOUTH AUSTRALIA

(Magistrates Appeals: Civil)

TECTRON INDUSTRIES PTY LTD v TAYLOR

[2006] SASC 175

Judgment of The Honourable Justice White

16 June 2006

MAGISTRATES - APPEALS FROM AND CONTROL OVER MAGISTRATES - SOUTH AUSTRALIA - APPEAL TO SUPREME COURT

CORPORATIONS - WINDING UP - CONDUCT AND INCIDENTS OF LIQUIDATION - EFFECT OF WINDING UP ON OTHER TRANSACTIONS - PREFERENCES

Appeal against judgment made in favour of respondent for payment pursuant to s 588FF of the Corporations Act 2001 (Cth) - appellant and insolvent company entered into transactions prior to company being wound up - not in dispute that transactions constituted unfair preferences and therefore insolvent transactions as defined under the Corporations Act - whether appellant had reasonable grounds for suspecting the insolvency of the company - whether a reasonable creditor in appellant's circumstances would, at the time of each of the payments, have had grounds for suspecting that the company was insolvent - whether the appellant had established the "good faith defence" - whether transactions part of a continuing relationship between supplier and debtor so as to establish a "running account defence".

Held:  "good faith defence" established by appellant prior to it receiving written notification of company's inability to pay outstanding accounts - "good faith defence" not established in relation to the period after appellant received written notification - "running account defence" held to be established in respect of all payments, but not necessary for it to be applied - appeal allowed and in lieu thereof judgment for the respondent against the appellant in the sum of $9,015.25.

Corporations Act 2001 (Cth), s 9, s 95A, s 588FA, s 588FC, s 588FE, s 588FF, s 588FG, referred to.
Sims v Selcast Pty Ltd (1998) 71 SASR 142; Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266; Re: Ermayne Pty Ltd (1999) 30 ACSR 330; Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477, considered.

TECTRON INDUSTRIES PTY LTD v TAYLOR
[2006] SASC 175

Magistrates Appeal

1. WHITE J               On 9 April 2002 Scott Morphett Electrical Pty Ltd (“SME”) was placed under administration.  On 31 May 2002 an order was made that SME be wound up.  The present respondent (“the liquidator”) was appointed its liquidator.

2. Prior to being wound up, SME carried on business as an electrical contractor.  Over a period of approximately 8-10 years, it purchased electrical goods relating to the installation of air-conditioning systems from the present appellant (“Tectron”).

3. The liquidator sued Tectron in the Magistrates Court to recover payments made by SME to Tectron in the “relation back period” (9 October 2001 to 9 April 2002). His claim was that 10 payments totalling $41,288.95 made by SME to Tectron in that period were “insolvent transactions” within the meaning of s 588FC of the Corporations Act 2001 (Cth) (“the Act”) and “unfair preferences” within the meaning of s 588FA of that Act. Because of the jurisdictional limit of the Magistrates Court, the liquidator limited his claim to $40,000. The total of the payments claimed by the liquidator was in fact $41,318.95, but as the liquidator limited his claim to $40,000, this discrepancy in the figures does not matter.

4. A magistrate upheld the liquidator’s claim.  He rejected two defences of Tectron.  This is an appeal against that decision.

   The Payments in Question

5. I set out in the following table details of the payments made during the relation back period.

Payment Date	Payment Amount	Date of Invoice/s to which Payments Related	Invoice Amount/Total	Balance Due and Payable to Tectron After Payments
1/11/01	$16,109.50	19/7/01	$16,109.50	$25,179.45
16/11/01	$6,518.60	19/7/01	$6,518.60	$18,660.85
30/11/01	$5,790.40	Various from 1/8/01 – 31/8/01	$5,790.40	$12,870.45
20/12/01	$3,885.20	31/8/01, 13/9/01	$3,885.20	$9,612.25
22/1/02	$2,613.60	13/9/01	$2,613.60	$7,192.25
4/2/02	$1,736.55	Various from 26/9/01 – 17/10/01	$1,736.55	$5,458.70
15/2/02	$1,184.05	4/10/01	$2,798.70	$4,274.65
28/2/02	$1,584.65	4/10/01	$2,798.70	$2,717.00
22/3/02	$1,045.00	25/10/01	$1,045.00	$8,699.68
28/3/02	$851.40	Various from 7/11/01 – 30/11/01	$851.40	$7,848.28

The Statutory Provisions

1. In the proceedings in the Magistrates Court, the liquidator invoked the statutory right to payment contained in s 588FF of the Act. By s 588FF, a court may, on the application of a liquidator, order a creditor to repay to the company monies paid by the company under a “voidable transaction”. A “transaction” includes a payment made.[1]  Relevantly to this case the content of a “voidable transaction” is found by reference to three other statutory provisions.

   [1] (2002) (Cth) s 9.

2. By s 588FA, a transaction to which a company being wound up and a creditor are parties is “an unfair preference” given by the company to the creditor if it results in the creditor receiving from the company, in respect of an unsecured debt, more than the creditor would receive from the company in respect of the debt if the transaction was set aside and the creditor proved for the debt in the winding up of the company.

3. By s 588FC of the Act, an unfair preference given by a company at a time when it is insolvent is an “insolvent transaction”.

4. By s 588FE of the Act, a transaction entered into by a company during the relation back period is voidable if it is an insolvent transaction.

   The Claim of the Liquidator

5. The liquidator’s contention in the present case was that the 10 payments made by SME to Tectron in the relation back period were unfair preferences made at a time when SME was insolvent and hence were “insolvent transactions” (s 588FC).  He claimed recovery of the amount of those payments (limited to $40,000) pursuant to s 588F.

6. For the purposes of the Act, a company is solvent if, and only if, it is unable to pay all its debts as and when they become due and payable.[2] It was not disputed at the trial that SME was insolvent as at the date upon which each of the 10 payments had been made. It was also established at the trial that the payments to Tectron resulted in it receiving more than it would have received had it proved for the debts in the winding up of SME. Each of the payments constituted therefore an “unfair preference” to Tectron within the meaning of s 588FA. It was therefore established that each payment was an “insolvent transaction” for the purposes of s 588 FC. Accordingly, subject to defences available to Tectron, the liquidator established his entitlement to an order pursuant to s 588FF.

   [2]        Corporations Act 2001 s 95A.

   Defences of Tectron

7. Tectron invoked both the so called “good faith defence” contained in s 588FG(2) and the so called “running account defence” contained in s 588 FA(3). Section 588FG(2) provides as follows:

   (2)A court is not to make under section 588FF an order materially prejudicing a right or interest of a person if the transaction is not an unfair loan to the company, or an unreasonable director‑related transaction of the company, and it is proved that:

   (a)     the person became a party to the transaction in good faith; and

   (b)     at the time when the person became such a party:

   (i)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(b); and

   (ii)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.

8. Section 588 FA(3) provides as follows:

   (3)    Where:

   (a)     a transaction is, for commercial purposes, an integral part of a continuing business relationship (for example, a running account) between a company and a creditor of the company (including such a relationship to which other persons are parties); and

   (b)     in the course of the relationship, the level of the company’s net indebtedness to the creditor is increased and reduced from time to time as the result of a series of transactions forming part of the relationship;

   then:

   (c)     subsection (1) applies in relation to all the transactions forming part of the relationship as if they together constituted a single transaction; and

   (d)     the transaction referred to in paragraph (a) may only be taken to be an unfair preference given by the company to the creditor if, because of subsection (1) as applying because of paragraph (c) of this subsection, the single transaction referred to in the last‑mentioned paragraph is taken to be such an unfair preference.

   The magistrate rejected each of these defences.  Tectron complained on appeal of that rejection.  It abandoned a third ground of appeal complaining that the magistrate had not provided sufficient reasons for his decision.

   The Good Faith Defence

9. In order to establish the good faith defence, Tectron had to establish four matters:

   1.     It had received the payments from SME in good faith.

   2.At the time it received each payment, it had no reasonable grounds for suspecting that SME was insolvent.

   3.At the time it received the payments, a reasonable person in its circumstances would have had no such grounds for suspecting that SME was insolvent.

   4.It had provided valuable consideration for the transactions.

10. A Mr Magor and a Mr McKenzie were the only two shareholders and directors of Tectron.  Its business was that of supplying air-conditioning componentry.  I infer that it was in business in a relatively small way:  its annual turnover being of the order of $350,000.  Mr Magor was the person who dealt with SME and was the relevant mind of Tectron for present purposes.  He gave evidence at the trial.  The magistrate appears to have accepted his evidence as reliable.

11. It is plain that each payment by SME related to an invoice rendered by Tectron in relation to the supply of goods.  It was clear therefore that Tectron had provided valuable consideration for each of the payments to it.

12. On the basis of the evidence of Mr Magor, the magistrate said that he was satisfied that Tectron had acted honestly.  I infer that the magistrate was satisfied that Tectron had received each payment without suspecting that SME was insolvent and without intending to obtain an unfair preference.  The critical elements of the offence were therefore the second and third matters outlined above.

13. Tectron had to prove two negative propositions.  First, that on the information known to it about SME, there were no reasonable grounds for suspecting that SME was insolvent.  Secondly, that a reasonable creditor in its circumstances would not have had grounds for suspecting SME’s insolvency.[3]

    [3]        Cf Sims v Selcast Pty Ltd (1998) 71 SASR 142 at 145-6.

14. The relevant meaning of “suspicion” is that stated by Kitto J in Queensland Bacon Pty Ltd v Rees:

    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 … a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence.[4]

    [4] (1966) 115 CLR 266 at 303.

15. Tectron had been trading with SME for 8-10 years.  SME would order componentry when it was successful in tendering for a project.  Tectron extended credit to SME on terms of trade which required payment by 30 days after the end of the month in which the transaction occurred.  It was, however, customary for it to allow its customers (including SME) some latitude in payment, because it knew that its customers commonly had to wait upon payment from their clients.

16. Historically, SME’s purchases from Tectron were relatively small (usually less than $3,000 and sometimes for a few hundred dollars only).  Mr Magor said that the relationship with SME had continued to 9 April 2002 in the normal way, save only that he had made some “concessions” because SME was involved in some large government contracts.  He was also accustomed to not anticipating payment in the month of January each year because that was the time when the building industry was slack because of the Christmas shutdown.

17. Mr Magor referred to a letter from SME dated 16 January 2002 which said:

    In regard to our outstanding accounts, we are in the process of working through your account.  Due to the difficulty of retrieving our own outstanding monies we are currently short of funds to pay outstanding accounts.  This will be rectified within a short period.  We hope you are able to understand our predicament and bear with us for the short time.  I hope this in no way hinders are association with your company and again we are sorry for the inconvenience.

18. Upon receipt of that letter, Mr Magor said that he spoke to Scott Morphett, the principal of SME.  He indicated willingness to support SME as the letter requested.  There was nothing in the conversation, he suggested, to indicate that SME was in “financial difficulty”.

19. The magistrate concluded:

    Despite Mr Magor’s confidence about SME’s ability to pay Tectron’s debts, alarm bells should have sounded when SME’s debt reached the level which it did in mid 2001 and when its payments fell substantially outside of the credit period allowed by Tectron.  SME was not a substantial customer.  Its purchases were mostly in the few hundred dollar range with a few in the one or two thousand dollar range and one substantial purchase of $14,645 plus GST.  SME was not even paying the invoices for the few hundred dollars within the credit period.

20. Later, the magistrate said:

    … I am in no doubt that Tectron should have been suspicious of SME’s solvency.  I expect there is an element of being wise after the event but there were various indicators that SME was a company in some financial trouble.

21. In these reasons, the magistrate did not differentiate between the second and third elements of the defence to which I have referred above.  I do not consider, however, that the magistrate overlooked the distinction. He had referred to it earlier in his reasons.  Further, the magistrate did not make express findings in relation to the second and third elements to be proved by Tectron.  It was desirable for him to have done so.  But in my opinion, the reasons of the magistrate are to be understood as indicating a conclusion by him that Tectron had not established either of the second and third elements:  ie, that it had no reasonable grounds for suspecting that SME was insolvent or that a reasonable person in its circumstances would not have had grounds for suspecting the insolvency of SME.  It is apparent, however, that the magistrate looked at the matter somewhat globally and did not differentiate between the information available to Tectron (and a reasonable creditor) at different times.  This is significant because, on Mr Magor’s evidence, the information available to Tectron concerning the solvency of SME changed significantly during the relation back period and in particular on 16 January 2002.

22. In submitting that the magistrate had erred in his conclusion, Mr Barnett, who appeared for Tectron, contended that none of the usual and traditional indicia of insolvency were present.  He relied very much in this respect on a comparison of the circumstances of this case with those considered by Wicks J in Re Ermayne Pty Ltd.[5]  The evidence indicated, he submitted, at the most some tardiness in the payment of accounts.  A schedule showing the payments made by SME and the invoices to which they related in the period from 1 June 2000 to 9 April 2002 showed, he submitted:

    1.that it was customary for SME to make payments outside the period stipulated by the terms of trade;

    2.that SME regularly made payments;

    3.that when allowance was made for two unusually large invoices in July 2001, the outstanding balance owed by SME had not increased over time in a way which would cause suspicion.

    [5] (1999) 30 ACSR 330.

23. Mr Barnett also referred to Mr Magor’s evidence that he had not received any information from the industry generally that SME was in financial difficulty.  Mr Magor enjoyed a good relationship with SME and had not detected any sign that SME was in financial difficulty.

24. As Mr Lazarevich, who appeared for the liquidator submitted, the question in this case is whether, at the time of each payment, Tectron had reasonable grounds for suspecting, or a reasonable creditor in Tectron’s circumstances would have had grounds for suspecting, that SME was unable to pay all its debts as and when they became due and payable, ie, as at the times required by Tectron’s terms of trade.

25. In my opinion, the magistrate’s conclusion that Tectron had reasonable grounds, and that a reasonable person in Tectron’s circumstances would have had reasonable grounds, for suspecting that SME was insolvent was well justified in respect of the period after 16 January 2002.  The letter from SME said expressly:  “We are currently short of funds to pay outstanding accounts” and “We hope you are able to understand our predicament.” (Emphasis added.)  There was nothing which occurred after 16 January 2002 to indicate that that predicament had been alleviated.  Although SME did make some payments, they were for relatively small amounts, and the payments were well after (in some cases three and four months) their due date.

26. The position prior to 16 January 2002 is less clear.  Mr Magor had had conversations with Scott Morphett in which Mr Morphett said words to the effect:

    I can’t pay you at the moment but some money is going to be coming in in the future and then I will be able to pay you.

    The evidence did not establish precisely when conversations along those lines occurred but it seems probable that it was prior to the payment on 1 November 2001 of the sum of $16,109.50.  I say that because the payment of $16,109.50 related to equipment provided by Tectron in relation to a government contract being performed by SME and Mr Magor said that his conversations with Mr Morphett related to payment in connection with that contract.

27. A schedule prepared by Mr Magor shows that as at 2 October 2001 the outstanding indebtedness of SME to Tectron had grown to $40,437.55.  Of this amount, approximately $22,600 was attributable to two unusually large invoices issued on 19 July 2001.  Making allowance for those, the outstanding balance had still grown from an amount which historically was generally less than $5,000 to approximately $18,000.  This was a significant outstanding balance in the context of Tectron’s trading with SME.

28. On the other hand, as at the commencement of the relation back period, the periods during which accounts remained outstanding (looked at generally) had not increased.  It did, however, increase (in most cases at least double) during the relation back period.  SME was late in making payments of quite small amounts (for example payments of less than $200).  I also note that no payment at all was made to Tectron in the months of June and September 2001.  Against that, Mr Magor’s schedule shows that commencing with the payment on 1 November 2001 SME continued to reduce its indebtedness to Tectron.  At the time of the letter of 16 January 2002, the amount due and payable by it to Tectron was $9,612.25.  This is significant because it is the position at the time each payment is made which is to be considered.  Furthermore, SME appeared to be behaving in the way which had been discussed with Mr Magor, namely, making regular payments to Tectron after it had received payment from its own customers.

1. In my opinion, much can be said either way.  I consider that both Tectron and a reasonable creditor in Tectron’s circumstances would have had grounds for suspecting (in the relevant sense) as from 9 October 2001 that SME was insolvent.  Such a reasonable creditor would have had grounds for so suspecting because SME had secured an unusually large amount of credit from Tectron, was overdue in discharging its liabilities, and because Mr Morphett had told Mr Magor that he could not pay Tectron until money came in in the future.  In addition to that, a reasonable creditor would have had grounds for suspecting insolvency from the fact that SME’s overall indebtedness to Tectron, after making allowance for the two unusually large invoices, had increased from levels which were generally less than $5,000 to approximately $18,000. 

2. However, I consider that the position changed with the payment of $16,109.50 on 1 November 2001.  The very fact of payment of that (relatively) large amount indicated that SME had funds with which to pay debts.  The payment on 1 November 2001 was followed by further payments of substantial amounts (on 16 November, 30 November, 20 December and 22 December).  Although these payments were made well after their due dates, they were substantial, and did reduce significantly the overall indebtedness of SME.  They too indicated an ability by SME to pay debts.  They would have had the effect of reassuring Tectron and  the hypothetical reasonable creditor.  Each would have seen a debtor doing what it said it would do to reduce its liability.  The fact that the payments were well overdue may have given Tectron and the hypothetical reasonable creditor cause to “wonder” about SME’s solvency, but I do not consider that it would have had “a positive feeling of actual apprehension or mistrust” about the solvency of SME.  The hypothetical reasonable creditor would have taken account in this respect of the latitude which had historically been allowed to SME.

3. In short, I consider that the magistrate’s conclusion with respect to the good faith defence has been shown to be incorrect in respect of the payments made between 1 November 2001 and 16 January 2002 inclusive.  The liquidator has proven an entitlement to be paid the sum of $9.015.25, being the aggregate of the payments made by SME after 16 January 2002.

   The Running Account Defence

4. My conclusion concerning the good faith defence makes it unnecessary to consider the running account defence.  This is because the indebtedness of SME to Tectron increased in the period 16 January 2002 to 9 April 2002.

5. But in case this matter should go further, I will state my conclusion about this defence shortly.

6. I adopt, with respect, the explanation of the running account defence by Santow J in Sutherland v Eurolinx Pty Ltd.[6]The effect of the defence is that where, as in this case, persons trade regularly with each other on credit terms and the liability of one rises with each purchase and falls with each payment, one does not, for the purpose of s 588FF, consider each payment in isolation. Instead one looks at the overall effect to determine the extent by which the supplier has been advantaged by the payments. This is done by comparing the highest amount owing during the relation back period with the amount owing at the last day. The difference between these two figures is the amount of the preference.

   [6] (2001) 37 ACSR 477 at 502-5.

7. A critical feature of the running account defence is that it requires the existence of a continuing relationship of debtor and creditor and that payments are made in the expectation that the supplier will continue to supply the debtor.

8. Often, there is no express statement to the effect that a payment is being made in the expectation that the supplier will continue to supply.  The existence of such an expectation has to be inferred from all the circumstances of the case.  As Barwick CJ said in Queensland Bacon Pty Ltd v Rees:

   In my opinion, it is enough if, on the facts of any case, the court can feel confident that implicit in the circumstances in which the payment is made is a mutual assumption by the parties that there will be a continuance of the relationship of buyer and seller with the resultant continuance of the relation of debtor and creditor in the running account, so that, to use the expressions employed in Richardson’s case (1952) 85 CLR 110 at 113: “it is impossible” – I interpolate, in a business sense – “to pause at any payment into the account and treat it as having produced an immediate effect to be considered independently of what followed …”[7]

   [7] (1966) 115 CLR 266 at 286.

9. With respect to the running account defence, the magistrate said:

   The essence of the continuing business relationship or running account defence requires payments to be made by SME with some connection for the future supply of goods by Tectron.  In this case all payments made by SME to Tectron were to discharge its existing indebtedness.  There is no apparent connection with the future supply of goods.  That essential pre-requisite is missing.

10. The basis for the magistrate’s finding that all payments were made to discharge the existing indebtedness and (by implication) that none were made to secure continuance of supply was not specified.

11. The conclusion of the magistrate that the payments were made to discharge an existing indebtedness is well justified.  That is clear from the fact that each payment of SME matched the amount of an outstanding invoice or invoices.  However, a finding to that effect does not exclude the payments having been made for concurrent purposes.  As the authorities reviewed by Santow J in Sutherland v Eurolinx Pty Ltd make clear, payments can be made for the dual purpose of discharging an existing indebtedness and to ensure further supply, without denying the availability of the running account defence.  In practice, the discharge or reduction of an existing indebtedness is often a prudent step taken by a customer to ensure the availability of continued supply.

12. In the present case, SME and Tectron had been trading in a rather similar way for 8-10 years.  It can be inferred from the way they conducted their relationship that Tectron was prepared to extend some indulgence to SME in order to attract further business, and that SME made payments regularly (albeit late) as a means of maintaining the relationship and thereby of continuing access to supplies.  I note that in the relation back period SME made six purchases in October 2001, four purchases in November 2001, two purchases in December  2001, one purchase in January 2002 and 13 purchases in March 2002.  This evidences that the relationship of supplier and customer did continue.  I also note that in the letter of 16 January 2002 SME expressed the hope that their present inability to pay Tectron “in no way hinders our association with your company”.  In all these circumstances, I consider that it should be inferred that a significant purpose of the payments was to maintain SME’s relationship with Tectron so as to maintain the availability of supplies.  That purpose co-existed with the purpose of discharging the existing indebtedness as found by the magistrate.

13. I consider therefore that the magistrate was in error in concluding that the payments had only one purpose and that the running account defence could not be invoked.

14. However, as I have said, given my findings on the good faith defence, and the increase of SME’s indebtedness after 16 January 2002, it is unnecessary to apply the running account defence in the circumstances of this case.

    Conclusion

15. I allow the appeal and set aside the judgment of the magistrate.  In lieu thereof there will be judgment for the plaintiff against the defendant in the sum of $9,015.25.  I will hear the parties as to interest and to costs.