Woodgate v Scansoft Belgium BVBA

[2006] NSWDC 204

CITATION:	Woodgate v Scansoft Belgium BVBA [2006] NSWDC 204
HEARING DATE(S):	14/6/2006, 15/6/2006, 29/6/2006
JUDGMENT DATE:	13 July 2006
JUDGMENT OF:	Rein SC DCJ
DECISION:	At [48].
CATCHWORDS:	Claim by liquidator to recover payments as unfair preferences - Insolvency, identity of company making payment, whether such payments as were made by the company were paid pursuant to a continuing business relationship and whether the creditor made payments in good faith.
LEGISLATION CITED:	Corporations Act 2001 (Cth) Bankruptcy Act 1966 (Cth)
CASES CITED:	Sandell v Porter (1966) 115 CLR 666 Re Emanuel (No 14) Pty Ltd (in liq); Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281; 24 ACSR 292; 15 ACLC 1099 (FCA, O’Loughlin, Branson and Finn JJ) Queensland Bacon Pty Ltd v Rees (1967) 115 CLR 266 Petagna Nominees Pty Ltd & Anor v A E Ledger 1 ACSR 547 Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195; 19 ACSR 285 Airservices Australia v Ferrier (Compass Airlines case) (1996) 185 CLR 483; [1995] HCA 57 In Petagna Nominees Pty Ltd v A E Ledger Liq of Linun Pty Ltd (in liq) (1989) 1 ACSR 547 Sutherland v Liquor Administration Board (1997) 139 FLR 206; 24 ACSR 176 Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477; [2001] NSWSC 230 Rees v Bank of New South Wales (1964) 111 CLR 210 Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195; 19 ACSR 285 Wily v Eastern Elevators Pty Ltd (2003) 45 ACSR 261; [2003] NSWSC 377; Sands & McDougall Wholesale Pty Ltd (in liq) v Commissioner of Taxation [1999] 1 VR 489; [1998] VSCA 76 Re Discovery Books (1972) 20 FLR 470 M & R Jones Shopfitting Co Pty Ltd (in liq) v National Bank of Australia Ltd (1983) 68 FLR 282 CSR Ltd v Starkey (1994) 13 ACSR 321 Re Weiss [1970] ALR 654 Clayton's Case (1816) 1 Mer 572; 35 ER 781 Re Baronga Nominees Pty Ltd (in liq) (1983) 8 ACLR 265 Walsh v Salzer Constructions Pty Ltd (2001) 3 VR 305; [2000] VSCA 228 Re Ermayne; Sims v Tech Holdings Pty Ltd (1998) 30 ACSR 330 Pegulan Floor Coverings Pty Ltd v Carter (1997) 24 ACSR 651; 15 ACLC 1293 Sparad (No 100) v J B Harkness (unreported, CA (NSW), Full Court, CA40665/93, 14 February 1997, BC9700197) Smith v Deputy Cmr of Taxation (1997) 75 FCR 339; 23 ACSR 611
PARTIES:	Giles Geoffrey Woodgate in his capacity as Liquidator of Marketing Results Pty Ltd (in Liq) [ACN 061 322 674] (First Plaintiff) Marketing Results Pty Ltd (In Liq) [ACN 061 322 674] (Second Plaintiff) Scansoft Belgium BVBA [ABN 110 717 336] (Defendant]
FILE NUMBER(S):	5189/2004
COUNSEL:	Mr G A Newton (Plaintiffs) Mr J Gruzman (Defendant)

JUDGMENT

1 The second named plaintiff is a company that was placed in liquidation on 12 May 2003 (“the Company”) and the first named plaintiff is the liquidator of that company (“Mr Woodgate”).

2 The defendant (“Scansoft”) is a Belgian company, which is the developer of various software programs such as Dragon Naturally Speaking and the eponymous Scansoft (an optical character recognition program). The claim by the Company and the liquidator is that Scansoft was paid seven royalty payments by the Company in the period January to April 2003 totalling $77,500 at a time when the Company was insolvent, and that these payments are required to be repaid as unfair preferences pursuant to s 588FA of the Corporations Act 2001 (Cth) (“the Act”). Mr G A Newton of counsel appears for the Company and Mr Woodgate, and Mr J Gruzman of counsel appears for Scansoft.

3 Scansoft admits that it received the amount of $77,500 by seven royalty payments in the period 22 January to 11 April 2003. It asserts that four of the seven payments were in fact made by Quadtel International Pty Ltd (“Quadtel”), a company related to the Company (“the Quadtel payments”), and only three were made by the Company. The plaintiffs accept that Quadtel made the four payments but assert that they should be treated as payments by the Company. The Company and Quadtel were both owned by Quadtel Ltd (“QTL”).

4 Scansoft:

(a) does not admit that the Company was insolvent between January and April 2003, the period in which the payments were made (“the insolvency point”);

(b) denies that the Quadtel payments were payments made by the Company (“the Quadtel point”);

(c) does not admit that any of the payments made, whether by Quadtel or the Company, were unfair preferences within the meaning of s 588FA of the Act (“the unfair preference point”);

(d) asserts that if the Company was insolvent and the payments or any of them would otherwise be treated as preferences, then s 588FA(3) applies, and that if it applies, then the extent of the preference is $5661.96 (see Exhibit “B”) (“the Continuing Business Relationship point”);

(e) relies on the defence set out in s 588FG(2) of the Act (“the good faith defence”).

5 The Agreement between the Company and Scansoft contained relevantly the following terms:

“ARTICLE II: GRANT OF LICENSE

2.1. Subject to all applicable terms and conditions hereof and in consideration of the payment of the license fees set forth herein, L&H hereby grants LICENSEE, during the Term of the Agreement, and LICENSEE accepts from L&H a non-exclusive, non-transferable and irrevocable, unless otherwise provided in the Agreement, license within the Territory to:

a) localize, manufacture, package, market the Licensed Programs as listed in Appendix A;

b) distribute to End Users copies of the Licensed Programs in the form of standalone boxed products (‘as such’);

c) use the Licensed Programs solely in connection with LICENSEE’s distribution and provision of technical support for the Licensed Programs.

…

ARTICLE III: PRICES AND TERMS

3.1. In consideration of the rights granted hereunder, LICENSEE shall pay L&H licensee fees for the Licensed Programs, pursuant to Addendum C.

3.2. Failing payment on time as mentioned here above, LICENSEE shall be deemed to be in default, if such late payment is not remedied within 30 days after written notice. In such case, LICENSEE shall be liable for interest at the rate of twelve percent (12%) per annum of the total amount due.

…

3.4. LICENSEE hereby authorizes L&H, and/or L&H-appointed independent auditors, to enter its premises, with one week notice, in order to inspect documents pertaining to the Licensed Program in any reasonable manner during regular business hours to verify LICENSEE’S compliance with the terms of this Agreement and to verify reported sales of the Licensed Program by LICENSEE.

...”

and

“ARTICLE IX: TERMS AND TERMINATION

9.1. The Initial Term of this Agreement shall commence on the Effective Date herein and shall be automatically renewed for one (1) year periods, unless terminated or cancelled as provided in section 2 or 3 of this Article:

9.2. This Agreement may be terminated for cause, as follows:

a) by LICENSOR, if LICENSEE fails to make timely payments or provide royalty reports as required hereunder, and any such failure is not remedied within thirty (30) days after receipt of written notice;

b) by LICENSOR, if LICENSEE expressly or impliedly repudiates this license by refusing to observe the restricted use or confidentiality requirements as mentioned in this Agreement or exceeding the license rights, LICENSOR may terminate this Agreement immediately, by providing written notice to LICENSEE stating such breach;

c) by either party, if a party ceases its business activities as a result of bankruptcy, dissolution, liquidation, or other causes, the other party may immediately terminate this Agreement by providing written notice to that party.”

6 Thus, essentially Scansoft (or its predecessors in title) had licensed the Company to make, package and sell in Australia various items of software in which Scansoft had title, and the Republishing Agreement was amended on 24 December 2002, 17 March 2003 and May 2003. The agreement required the Company to pay a royalty (a percentage but subject to a fixed amount per sale) to Scansoft in respect of software. The agreement granted the Company a licence to manufacture, package, market and distribute the relevant programs.

7 From May 2002 (see Annexure C to Mr Langenhove’s statement) the Company was required within 10 days of the end of the month to provide monthly reports showing net sales and the quantity of programs sold in the relevant month, with royalties to be paid within 30 days of the end of the month.

The Insolvency Point

8 Mr Woodgate, the liquidator, has prepared a report (Exhibit “GGW10”), in which he expresses the view that as from 31 December 2002, the Company was insolvent. The Company, on liquidation, was established as having unsecured assets of approximately $400,000 and unsecured debts in excess of $4 million. There was an extensive attack on Mr Woodgate’s credit, which included reference to his failure to clearly state who had been involved in the preparation of the report, and his having spoken to a member of his staff whilst he was under cross examination and having given, it was alleged, a deliberately false answer in relation to that aspect. The problem with the attack is that it did not focus upon any of his material conclusions in his report. It was never put to him that he was in error or that his assertion that he had himself checked the entire contents of the report was false. I am satisfied on the basis of his opinion and the documentary material attached to it including the statutory demand for $159,819.23 made on 12 December 2002 (p A92 Exhibit “C”) by another creditor and not met within 21 days, that the Company was at least from 31 December 2002 insolvent, that is unable to pay out of its own money all of its debts as and when they became due and payable: Sandell v Porter (1966) 115 CLR 666, and see s 95A of the Corporations Act 2001 and the discussion at pp 434-8 of McPherson, “The Law of Company Liquidation”, LBC Information Services.

The Quadtel Point

9 In support of its claim that Quadtel payments to Scansoft are to be treated as payments by the Company, Mr Newton relies on the case of Re Emanuel (No 14) Pty Ltd (in liq); Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281; 24 ACSR 292; 15 ACLC 1099 (FCA, O’Loughlin, Branson and Finn JJ). Mr Gruzman makes no challenge to the principle laid down in Macks but submits that no basis for application of the principle to this case has been established here. In Macks, money was owed by Macks to Blacklaw and to EFG. Macks and EFG entered into an agreement whereby EFG’s solicitors paid the amount directed by Macks to Blacklaw. The question of principle was described in the following terms (where Macks is A, EFG is B and Blacklaw is C) by the Court at ALR 282:

“‘A’ contracts with ‘B’ that in settlement of all claims between them B will, inter alia, make payments both to A and, at A's direction, to ‘C’. C is A's creditor and the payment to C, if made and accepted, will result in a partial discharge of A's debt to C. If that payment is made to and accepted by C, can it properly be said that A and C are parties to a ‘transaction’ deemed an unfair preference by s 588FA of the Corporations Law?”

and was answered in the affirmative – the dealing had two constituent parts and B’s debt to A was a valuable chose in action, which was utilised in the payment by B to C.

10 The plaintiff relies on paras 3 and 22-32 of the statement of Mr Woodgate (Exhibit “A”) and p 2 of the Report as to Solvency (Exhibit “GGW10”), and pp A383-384 of Exhibit “C”. What this material establishes is that there was a close relationship between the business activities of Quadtel, QTL and the Company and even that there was mixing of the business undertakings, but it does not establish that Quadtel owed money to the Company. Mr Newton did not assert that it could be inferred that Quadtel owed money to the Company and although that may well have been the case I do not think there is sufficient evidence to found the inference. In the absence of evidence that Quadtel in paying Scansoft was discharging a debt owed by Quadtel to the Company, I do not think the principle in Macks’ case has any application. It follows in my view that it has not been established that the payments made by Quadtel were payments made by the Company with the result that the amounts cannot be claimed by the liquidators of the Company from Scansoft. However, in the light of a concession made by Mr Gruzman on behalf of Scansoft that all payments could be taken into account for the purpose of determining the amount of preference under s 588FA(3), success on this point has no impact on the result if Scansoft is successful on the Continuing Business Relationship Point.

The Continuing Business Relationship Point and Unfair Preference Point

11 Section 588FA is a new legislative provision introduced in 1992. The explanatory paper produced at the time of the bill described the equivalent of subs (3) as:

“Subsection 588FA(2) provides that where a transaction is, for a commercial purpose, an integral part of a continuing business relationship such as a running account between a creditor and the company, it should not be attacked as a preference, but rather the effect of all the transactions which form the relationship between that creditor and the company should be taken into account as though they constituted a single transaction. This provision is aimed at embodying in legislation the principles reflected in the cases of Queensland Bacon Pty Ltd v Rees (1967) 115 CLR 266 and Petagna Nominees Pty Ltd & Anor v A E Ledger 1 ACSR 547. The effect of these principles is that it is implicit in the circumstances in which payments are made to reduce the outstanding balance in a running account between purchaser and supplier that there is a mutual assumption that the relationship of purchaser and supplier would continue as would the relationship of debtor and creditor. The net effect, therefore, is such that payments ‘in’ are so integrally connected with payments ‘out’ that the ultimate effect of the course of dealings should be considered to determine whether the payments are preferences.”

See para 1181 of the note and see para 1042 of the Explanatory Memorandum, which is in the same terms.

12 Mr A Keay in McPherson, “The Law of Company Liquidation” (4th ed) points out that the memorandum anticipated that principles developed at common law can be used in interpreting and applying s 588FA(3), and see Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195; 19 ACSR 285 as an example of this.

13 The legislation was introduced (but without retrospective operation) before the High Court’s decision in Airservices Australia v Ferrier (Compass Airlines case) (1996) 185 CLR 483; [1995] HCA 57, and indeed Toohey J in dissent made reference to s 588FA noting that the application of that provision might lead to a different result to that which applied to situations governed by s 122 of the Bankruptcy Act 1966 (Cth) (see at 526). The majority of the Court (Dawson, Gaudron and McHugh JJ) were of the view, that all but one of the transactions impugned were not caught by s 122 of the Bankruptcy Act. Brennan CJ and Toohey J were of the view (like the Full Federal Court) that all transactions were preferences.

14 If it be correct that s 588FA is intended to embody the principles established by the High Court in Queensland Bacon Pty Ltd v Rees (1967) 115 CLR 266, then the law’s further exposition in Airservices would also be relevant to s 588FA, although there is open an argument that s 588FA is more expansive (and favourable to creditors) than Airservices and ought not be constrained by it.

15 In Petagna Nominees Pty Ltd v A E Ledger Liq of Linun Pty Ltd (in liq) (1989) 1 ACSR 547 (to which reference is made in the Explanatory Memorandum) Wallace and Franklyn JJ (with whom Malcolm CJ agreed) referred with approval to the following statement of principle found in an earlier edition of McPherson (above):

“Genuine payments made by the company to reduce a general debit as it stands from day to day and in order to maintain a genuine business relationship that promises advantages to both the company and its creditor are not preferences. This is because there is a mutual assumption by the parties that the business relationship of buyer and seller will continue with the result that the relationship of debtor and creditor will continue in the running account between the parties. There is no attempt to terminate this relationship but rather to ensure its continuance to the mutual benefit of the parties. In these circumstances payments made by the company to its supplier should not be viewed in isolation and attacked as preferences.”

See pp 552-3 per Wallace J and 563 per Franklyn J.

16 Section 588FA(3), it was noted by Young J (as he then was) in Sutherland v Liquor Administration Board (1997) 139 FLR 206; 24 ACSR 176, is not easy to comprehend. He offered a summary of its provisions (in a simple case) at ACSR 181:

“it means that if a supplier and consumer are constantly trading, one constantly supplying goods and the other constantly making payments, then one does not look at transactions in isolation but looks at the overall effect at the beginning and the end of the relevant period. That is an inadequate summary but it is perhaps generally more meaningful than the words of the subsection itself.”

17 In Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477; [2001] NSWSC 230, Santow J adopted the paraphrase but added that in calculating the amount of any preference, he would adopt the approach in Rees v Bank of New South Wales (1964) 111 CLR 210, namely by looking at the ultimate effect on the balance of the account between company and creditor and would do so by reference to the highest amount during the relation back period. This reference to the highest amount accords with the approach taken to s 122, and there was in this case no dispute that it was appropriate (and see Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195; 19 ACSR 285, in which the argument that the approach to s 588FA(3) should not be constrained by the approach to s 122 of the Bankruptcy Act was rejected by Burley J).

18 For s 588FA(3) to operate, the following conditions must be satisfied:

(1) there is in the relevant period a continuing business relationship between the creditor and the company;

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

(3) the transactions in question are an integral part of the continuing business relationship.

If those preconditions are met then:

(4) all the transactions forming part of the relationship (both credits and debits) (in the relevant period) are to be totalled and treated as a single transaction;

(5) the single transaction, if it is a negative amount, and it results in the creditor receiving from the company more than the creditor would receive if the transactions were set aside and the creditor to prove for the debt in the winding up (assuming no secured debt), is an “unfair preference” and will have to be paid back to the company;

(6) a gloss on (5) is that the high point of indebtedness within the relevant period is compared to the position as at the end of the relation back period: per Santow J in Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477; [2001] NSWSC 230.

Continuing Business Relationship

19 The requirement of a “continuing business relationship” was obviously intended to encompass the running account situation but it had been indicated even in respect of s 122 cases that “running account” was only a convenient tag. In Airservices Australia v Ferrier (1996) 185 CLR 483; [1995] HCA 57, the majority (Dawson, Gaudron and McHugh JJ) said at 505-6:

“If the record of the dealings of the parties fits the description of a ‘running account’, that record will usually provide a solid ground for concluding that they conducted their dealings on the basis that they had a continuing business relationship and that goods or services would be provided and paid for on the credit terms ordinarily applicable in the creditor's business. When that is so, a court will usually be able to conclude that the parties mutually assumed that from a business point of view each particular payment was connected with the subsequent provision of goods or services in that account. Sometimes, however, the transactions recorded in the account may be so sporadic that a court cannot conclude that there was the requisite connection between a payment and the future supply of goods even though the account was kept ‘in the ordinary form of a running account in which debits and credits are recorded chronologically and in which payments are not shown as attributable to any particular deliveries but are brought generally into credit’ [Re Weiss [1970] Arg LR 654 at 659]. Thus, it is not the label ‘running account’ but the conclusion that the payments in the account were connected with the future supply of goods or services that is relevant, because it is that connection which indicates a continuing relationship of debtor and creditor. It is this conclusion which makes it necessary to consider the ultimate and not the immediate effect of individual payments [cf Rees (1964) 111 CLR 210 at 221-223, per Kitto J]. As Barwick CJ said in Queensland Bacon Pty Ltd v Rees [(1966) 115 CLR 266 at 286]:

‘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 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], “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 …”.’” [emphasis added]

20 The plaintiffs submit that the payments were not an integral part of a continuing business relationship because:

(1) The payments were not made to secure continued provision of goods or services. The Company was entitled to manufacture and sell software pursuant to the Republishing Agreement regardless of payment made “so long as it remained in force and unless it was terminated by Scansoft”. Accordingly, say the plaintiffs, it was not implicit in the circumstances in which payments were made that there would be a continuance in the relationship of buyer and seller with resultant continuance of the relation of debtor and creditor.

(2) Each payment was to be applied by Scansoft to an invoice for a specified amount of royalties.

(3) With respect to Scansoft’s claim for November 2002 and earlier royalties, the payments were made as part of a proposed instalment arrangement for specified invoices during those months – they were not payments made as part of a running account – the purpose of such payments was to extinguish past indebtedness. By the time of payments in March 2003 the outstanding invoices were at least 60 days overdue.

The plaintiffs rely on Wily v Eastern Elevators Pty Ltd (2003) 45 ACSR 261; [2003] NSWSC 377; Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477; [2001] NSWSC 230 and Sands & McDougall Wholesale Pty Ltd (in liq) v Commissioner of Taxation [1999] 1 VR 489; [1998] VSCA 76.

21 In Airservices Australia v Ferrier (1996) 185 CLR 483; [1995] HCA 57, the creditor was a statutory body that provided services to the debtor, Compass, with respect to the terminal and en route navigation, meteorological information, rescue and firefighting. Airservices provided the relevant services and debited Compass’s account on the first day of each month for services provided in the preceding month, and with penalties for late payment during the months July to December 1991. The debit balance of the account after 1 August 1991 was in excess of $10 million. Compass went into liquidation on 20 December 1991. Compass made nine payments totalling $10.351 million and Airservices provided services in excess of $19 million and imposed penalties of $719,000 (approximately). The following passages from the majority judgment (with emphasis added), in addition to the passage already quoted, are I think relevant to the present case, and they also highlight the close connection between the Commercial Relationship Point and the Unfair Preference Point:

(1) “If the sole purpose of the payment is to discharge an existing debt, the effect of the payment is to give the creditor a preference over other creditors unless the debtor is able to pay all of his or her debts as they fall due. But if the purpose of the payment is to induce the creditor to provide further goods or services as well as to discharge an existing indebtedness, the payment will not be a preference unless the payment exceeds the value of the goods or services acquired. In such a case a court, exercising jurisdiction under s 122 of the Bankruptcy Act, looks to the ultimate effect of the transaction. Whether the payment is or is not a preference has to be ‘decided not by considering its immediate effect only but by considering what effect it ultimately produced in fact’ [Rees v Bank of New South Wales (1964) 111 CLR 210 at 221-222].” (at 502)

(2) “As a consequence, a payment made during the six month period cannot be viewed in isolation from the general course of dealing between the creditor and the debtor before, during and after that period. Resort must be had to the business purpose and context of the payment to determine whether it gives the creditor a preference over other creditors. To have the effect of giving the creditor a preference, priority or advantage over other creditors, the payment must ultimately result in a decrease in the net value of the assets that are available to meet the competing demands of the other creditors [cf Re Discovery Books (1972) 20 FLR 470 at 475, per Fox J: ‘one must ultimately come back to considering whether by reason of the payment, or dealing, there is less money available for the general body of creditors.’].” (at 502)

(3) “Thus, a debtor does not prefer a creditor to the other creditors [Richardson (1952) 85 CLR 110 at 133; Queensland Bacon (1966) 115 CLR 266 at 284; Re Weiss [1970] ALR 654 at 658; Re Discovery Books (1972) 20 FLR 470 at 475; M & R Jones Shopfitting Co Pty Ltd (in liq) v National Bank of Australia Ltd (1983) 68 FLR 282 at 289; CSR Ltd v Starkey (1994) 13 ACSR 321 at 325] if he or she pays a debt, or part of it, to induce the creditor to supply goods of equal or greater value than the amount of the payment. In that situation, it is of no relevance that the debt that is discharged happens to be a stale one. [Re Weiss [1970] ALR 654 at 658] If the present value of the goods supplied is equal to or greater than the payment, the other creditors are no worse off. They are in the same position that they would have been in if the parties had so structured the transaction that the debtor paid for the new supply of goods instead of discharging the old debt.” (at 502-3)

(4) “The court looks to the business effect of the parties’ dealings which almost invariably proceed on the understanding, sometimes express but more often assumed, that the creditor will continue to supply goods or services to the debtor on a credit basis as long as the debtor substantially adheres to their credit arrangements.” (at 503)

(5) “If at the end of a series of dealings, the creditor has supplied goods to a greater value than the payments made to it during that period, the general body of creditors are not disadvantaged by the transaction — they may even be better off. The supplying creditor, therefore, has received no preference. [See, for example, CSR Ltd v Starkey (1994) 13 ACSR 321 at 324] Consequently, a debtor does not prefer a creditor merely because it makes irregular payments under an express or tacit arrangement with the creditor that, while the debtor makes payments, the creditor will continue to supply goods. [Re Weiss [1970] ALR 654; CSR Ltd v Starkey (1994) 13 ACSR 321] In such a situation, the court does not regard the individual payments as preferences even though they were unrelated to any specific delivery of goods or services and may ultimately have had the effect of reducing the amount of indebtedness of the debtor at the beginning of the six month period. [Re Weiss [1970] ALR 654 at 659-61] If the effect of the payments is to reduce the initial indebtedness, only the amount of the reduction will be regarded as a preferential payment. [Queensland Bacon (1966) 115 CLR 266 at 291; CSR Ltd v Starkey (1994) 13 ACSR 321 at 325]” (at 503-4)

(6) “Even where payments are expressly made for the purpose of reducing a debt earlier incurred as well as for the purpose of obtaining further goods or services, only the amount representing the reduction of the opening debt for the period will be regarded as a preference. [Rees (1964) 111 CLR 210 at 221, 223]” (at 504)

(7) “Apart from the fact that Airservices was a public authority determining and imposing charges according to a statutory regime, the case was a common one. It was the everyday case of a creditor supplying services to an undercapitalised and illiquid debtor who promised to clear its debt and pay new debts as they fell due, but who got further behind as month followed month. It was the very common situation of a debtor with a running account whose debit balance at the end of the six month period was greater than at the beginning, notwithstanding the making of large payments during that period. If the result of the dealings of Airservices and Compass is looked at from a business viewpoint, it is difficult to see how Airservices obtained any preferential treatment.” (at 506)

The question of payments being appropriated to old debts and penalties was considered of no significance by the majority:

(8) “The Full Court placed great significance on the fact that the payments were appropriated to old debts and penalties. But with great respect to their Honours, we do not think that that fact has any significance. Indeed, where the relationship of debtor and creditor contemplates further debits and credits, it is difficult to see how the appropriation of a payment to an earlier debt has any significance at all unless, as in Rees v Bank of New South Wales, [(1964) 111 CLR 210] the parties expressly agree that one of the purposes of the payment is to permanently reduce the level of indebtedness below the level existing at the time of the agreement. Even then, as Rees assumes, where the relationship is a continuing one, the preference will be no more than the amount that constitutes the difference between the indebtedness at the commencement of the agreement and the indebtedness at the end of the six month period. Apart from cases where there is such an agreement, the appropriation of a payment to a past debt will generally have no bearing on the issue of preference. [In the absence of such an agreement, the payment would in any event be appropriated as a matter of law to the oldest debt: Clayton's Case (1816) 1 Mer 572 at 608; 35 ER 781 at 792-3] After all, both the creditor and the debtor have a real commercial interest in giving priority to discharging the oldest debt in the account. Both sets of accounts will present their respective enterprises in a better light if the oldest debts are discharged first. Where the relationship appears to be a continuing one, the fact that the parties agree to appropriate the payment to the oldest debt is neither unusual nor surprising. In that context, it can seldom, if ever, provide any ground for concluding that the payment was not connected with the future supply of goods or services.” (at 508)

22 In relation to the last payment by Compass to Airservices, the majority regarded it as a preference. It was made the day before Compass went into liquidation, and the creditor, with a strong suspicion that Compass would “fold” the next day, demanded payment of $3 million (approximately) supported by an irrevocable authority and direction to its bank, and it imposed liens over aeroplanes that Compass operated. On the evidence, said the majority (at 510), the better view was that “in making its demand Airservices was looking backwards rather than forwards; looking to the partial payment of the old debt rather than the provision of continuing services”.

23 In my view, the following factual matters are here significant:

(1) There was an ongoing relationship between the Company and Scansoft of licensor and licensee with a requirement for royalty payments to be made and adjustment to be made and a continuation of the right in the Company to manufacture and sell software.

(2) The continuation of the relationship between the Company and Scansoft was to the benefit of the Company because without continuation of the licence it could not make (used in a broad sense) and sell the product. The license was thus akin to a raw ingredient of a physical product. It is true that strictly neither goods nor services were being supplied, but the right to manufacture and market based on the use of intellectual property seems to me to fall within a similar compass. If sales could not be made of software then the Company would have no income. True it is that Scansoft was not in a position to terminate the license agreement without giving notice, but it had that option throughout the relevant period, and had payments not continued to be made it may well have done so. In Airservices, the creditor thought it could not suspend services and that was not seen as significant by the majority.

(3) In the relevant period the Company paid a total of $77,500 to Scansoft but it also incurred fresh liabilities to Scansoft as royalties on further sales of product, so that the total debt to Scansoft reduced by, in fact, only $5661.96 in the relevant period, and the present case seems to be similar to Airservices, save that as at the end of the period in this case there had been here a small reduction of the total debt. To that extent (subject to the good faith defence) there is a preference but not otherwise. See [21](8) above.

24 Against these factors, I think it is relevant that the payments were behind and that they were made as part of an instalment plan (see [20](3) above) but that fact does not outweigh the overall fact that the relationship between the Company and Scansoft was an ongoing one (and the license was not only current at all times with a life of 12 months but it was renewed even in March 2003 and even in May 2003), or prevents the payment as being an integral part of the relationship as they are required to be for s 588FA(3) to operate. I do not think the fact that Scansoft requested the Company to pay off the old debts makes the situation one comparable with the last of the payments in Airservices, and see [21](3), (6) and (8) above. The argument advanced by Mr K Barlow in his article “Voidable Preferences and the Running Account – The High Court Reconsiders” (1998) 26 ABLR 82, that the majority’s approach to the last payment was inconsistent with the principles adopted in relation to the other payments, was not the subject of argument, so fortunately I do not need to consider that point further.

25 So far as the plaintiffs’ argument identified at [20](1) above is concerned, I think it is beyond doubt that a continuation of the relationship of licensor and licensee was contemplated and that relationship included a continuation of accounting for royalties (and it appears adjustments: see Exhibit “B”) and the making of sales of the software throughout the licensee period. So far as the plaintiffs’ argument identified at [20](2) above is concerned, the contention is inconsistent with the contention at paragraph 11(c) of the plaintiffs’ written submissions that the payments were not tied exactly to any particular invoice, but in any event Airservices establishes that the fact that a payment is tied to a particular invoice does not make the payment an unfair preference in the context of a continuing business relationship: see [20](8). That is not to say that the finding of a running account will not be made easier where the relevant payments are not made with respect to any particular invoice: see Re Baronga Nominees Pty Ltd (in liq) (1983) 8 ACLR 265 at 268-9.

26 A further argument was advanced in the plaintiffs’ further written submissions of 3 July 2006, that each relevant payment “was made to end the relationship of creditor and debtor in relation to the specific invoice to which payment was applied”. That argument, it seems to me, does not focus on the commercial relationship at all and approaches the matter in a fashion quite inconsistent with the terms of s 588FA(3) and the approach in Airservices.

27 The purpose of the payments was, I infer, not only to pay the pre-existing debts, but to secure the continuation of the license, which was in effect an asset of the business of the Company, and permitted further sales to be made and hence income derived.

28 Mr Woodgate himself continued to make payments of royalties to Scansoft during his administration, which only underscores the importance of maintenance of the licence agreement for the ongoing sales of product and hence derivation of income by the Company.

29 Reliance was placed on Wily v Eastern Elevators Pty Ltd (2003) 45 ACSR 261; [2003] NSWSC 377. It is a case dealing with a building contract, and a case in which Dunford J followed Walsh v Salzer Constructions Pty Ltd (2001) 3 VR 305; [2000] VSCA 228.

30 Walsh v Salzer was a case concerned with progress payments made by an owner to a builder under a building contract where the owner had agreed to pay a fixed lump sum.

31 In Walsh v Salzer the trial judge (Byrne J) had rejected the “running account” argument of the builder but held that the payments received under a fixed lump sum contract did not amount to a preference on other grounds. On appeal this conclusion was not disturbed – Winneke P expressed his agreement with Byrne J’s conclusion on the running account. The ratio of the case was not founded on the running account point but obviously the expression of opinion by Byrne J and Winneke P is entitled to considerable respect (as is the acceptance of their approach by Dunford J).

32 Whilst I think, with respect, it is arguable that the conclusion that payment of progress claims that results in continuation of construction and consequent benefit to the owner of the site is not part of the ongoing business relationship (and hence is a preference) is erroneous, I do not need to express a firm view because I am concerned here with a quite different factual scenario, namely a continuing licence agreement for royalties based on sales of software in an established business framework and a re-negotiated agreement in 2003, and I do not think that Wily or Walsh v Salzer, even if correct, lead to the conclusion that the payments made here were not integral to a continuing business relationship.

33 I do not think that Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477; [2001] NSWSC 230 or Sands & McDougall Wholesale Pty Ltd (in liq) v Commissioner of Taxation [1999] 1 VR 489; [1998] VSCA 76, which are succinctly and helpfully summarised in Wily, take the matter any further.

34 The view to which I have come is that there was a continuing business relationship between the Company and Scansoft within the meaning of s 588FA(3), and that the royalty payments were payments which were an integral part of the continuing business relationship, and that it is necessary to look at the position over the relation back period as one transaction. The parties are agreed that on this basis the amount derived from the calculation in Exhibit “B” leading to a figure of $5661.96 as the amount of the preference is correct.

35 Mr Gruzman accepted that success on the Quadtel payments issue did not affect the indebtedness based on the approach under s 588FA(3), and hence there is no need to determine what effect exclusion of those amounts would have.

The Good Faith Defence

36 The good faith defence was considered by Santow J in Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477; [2001] NSWSC 230. His Honour pointed to the three requirements that the defendant must establish:

(1) that the payments were made in good faith;

(2) that the defendant subjectively had no reasonable grounds for suspecting that the company was insolvent at the time it received the payment;

(3) that no reasonable person in the position of the defendant would have suspected that the company was insolvent.

37 He drew the following propositions from authority:

(1) The onus lays on the creditor in establishing each of these matters.

(2) “Good faith” means to act with propriety and honesty, and a subjective test is applied: Re Ermayne; Sims v Tech Holdings Pty Ltd (1998) 30 ACSR 330.

(3) “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’s Dictionary expresses it. Consequently, a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence”: per Kitto J in Queensland Bacon at 303.

(4) No single factor invariably establishes that there was or should have been the relevant suspicion. The Court is required to look at the matter not with the benefit of hindsight but through the contemporary eyes of the parties. The Court looks at the factors pointing to insolvency and the cumulative impact that knowledge of them should have had, or did have upon the payee, as well as countervailing factors and circumstances which could have tended to dispel suspicion at the time: Eurolinx at [43].

(5) Regard should be had to the commercial reality derived from the particular industry to the facts: Pegulan Floor Coverings Pty Ltd v Carter (1997) 24 ACSR 651; 15 ACLC 1293 – then if instalment payments and post-dated cheques were regularly used, their use in a particular matter would not necessarily indicate insolvency.

(6) Priestley JA in Sparad (No 100) v J B Harkness (unreported, CA(NSW), Full Court, CA40665/93, 14 February 1997, BC9700197) observed that undue weight should not be placed on dilatory payment – since debts are not always paid on time by solvent traders.

(7) The question should be determined in the light of all the circumstances which existed at the time and not with the benefit of hindsight: at [46], referring to Smith v Deputy Cmr of Taxation (1997) 75 FCR 339; 23 ACSR 611.

38 I respectfully adopt the approach taken in Eurolinx – and it was not suggested I should do otherwise, although as I shall outline, a difficulty arose which had not been present in Eurolinx.

39 The defendant relied on the evidence of Ms Gerda Cobbaert, Mr Geo Van Langenhove and Mr Jan Anthierens. Ms Cobbaert was the person in Belgium handling the account. She was made available for cross-examination. Her evidence was that she did not suspect that the Company was insolvent and she was not cross-examined to the effect that she was. She gave evidence of the arrangements made to pay by instalments to which I shall refer below. Mr Langenhove gave evidence by statement (see Exhibit “2”) but he was not required for cross-examination. Ms Cobbaert admitted that she did let Mr Bob Anderson, who I infer was Scansoft’s sales representative in Australia, know about the Company’s default, but she said she had done so as a matter of courtesy. Mr Anthierens gave evidence by statement (see Exhibit “3”) and he was not required for cross examination.

40 The plaintiffs point to the following undisputed facts:

(1) On 16 January Ms Cobbaert sent an email to the Company noting an overdue balance for November and December invoices of $64,793.04 and requesting that she be informed when payment be made: paras 4 and 5 of Exhibit “1”.

(2) On 21 January Mr Brennan (the manager of the Company) sent an email proposing an instalment arrangement (p A352 of Exhibit “C”) in which he said “I will aim to make the following payments”. The amounts were stated to be for a group of specific invoices – $10,000 for five weeks, with a final payment of $12,793.04.

(3) The first payment was made on time (but came from Quadtel). The second payment (which also came from Quadtel) was made by the due date but $2500 short. No explanation was given. No further instalments were paid in February and no explanation was given for the non-payment.

(4) Ms Cobbaert inquired on 19 February about payments. Mr Brennan replied, saying that “I am leaving the Company at the end of the month. I have passed on your emails to Bruce and Martin for their review”. Ms Cobbaert made enquiries by email on 24 February 2003, which were not answered, and 5 March 2003. On 6 March 2003 the Company indicated a payment of $15,000 had been paid on 5 March 2003 (that payment was in fact made by Quadtel).

(5) Between 6 March 2003 and April 2003 the Company made the following payments:

(a) $15,000 – 11 March 2003;

(b) $10,000 – 21 March 2003;

(c) $10,000 – 4 April 2003 (Quadtel);

(d) $10,000 – 11 April 2003.

(6) The Republishing Agreement entitled Scansoft to terminate if the licensor failed to make timely payments or provide royalty reports and such failure was not remedied within 30 days of receipt of written notice (para 17 of Mr Anthierens’ statement: Exhibit “3”), but it had not done so.

41 I invited submissions as to how s 588FG(2) would operate in the context of a continuing business relationship. Mr Gruzman contended that the Court should look at the facts and circumstances as known to the creditor at the end of the transaction period, not at isolated points during the period. Mr Newton contended that facts and circumstances that objectively ought to have created suspicion as to insolvency at any point in the period was sufficient. As a fall back position he contended that the Court should, having determined the net preference (ie here $5661.96), then determine the position as at the date of each payment and where absence of reasonable grounds for suspicion (or actual suspicion) was not negatived by the defendant, apportion on a pro rata basis an amount for that payment.

42 In Airservices, the majority noted that the Court would treat the last payment or payments: “or so much of them as equal the preferential amount, as the relevant payments. So, if after a course of dealing, a creditor has decreased its initial indebtedness by $10,000 and the last two payments were for $7000, the circumstances surrounding each of these two payments are relevant in determining whether the creditor is entitled to the protection of s 122(2)(a) in respect of the $10,000 preference” (at 504) (my emphasis).

43 Mr Ken Barlow in his article (above) said of s 588FA: “It seems clear that, for this purpose, one assumes that the single transaction took place immediately before the winding up of the company. This is because one does not look at the immediate effect of each transaction, but at the effect at the end of the series”: p 91.

44 A different view was taken, however, in Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195; 19 ACSR 285. Burley J thought that since the transaction was a single transaction that encompassed the whole period, then the matters required to be proved had to be proven for the duration of the continuing business relationship.

45 I was initially attracted to Mr Gruzman’s argument that since the Court is concerned with the position having regard to the net position at the end of the period, then it is the creditor’s knowledge as at the end of the period that is relevant. On this basis, if the creditor has learnt of facts that ought on their own to have given rise to a suspicion of insolvency, but later learnt of further facts that dispelled the suspicion (or would reasonably do so), then the defence will have been made out. Although he did not say so, I think that the passage from Airservices cited in [42] above supports his argument. However, Airservices was not concerned with s 588FA(3) and I think that there is force in Burley J’s view that since the transaction is, by s 588FA(3), required to be treated as a single transaction, the entire period (or at least the period from the high point of indebtedness to the time of the last payment) is relevant. Whilst the matter is not free from doubt, I am disposed to adopt the approach of Burley J since it focuses more precisely on the legislative provision and in any event is not clearly wrong.

46 I accept that Scansoft at all times acted in good faith (indeed no argument was put to the contrary). I also accept that the fact that the Company renewed the Republishing Agreement is of relevance, but having considered all the evidence I was left unpersuaded that a reasonable person in the position of Scansoft would not, at least by early March 2003, have suspected that the Company was unable to pay its debts as and when they fell due. My reasons are:

(1) the royalty payments are derived from sales of the product – the sale has by definition been processed for the royalty to be payable;

(2) the amount of the unpaid royalty was quite high and had been in excess of $50,000 and outstanding for three months by 22 January;

(3) no satisfactory explanation was offered by the Company to Scansoft for non-payment;

(4) an instalment plan having been offered, no explanation was given for non-payment in accordance with the plan; in February there were no payments;

(5) the manager of the Company indicated to Scansoft he was leaving without offering any explanation;

(6) Scansoft regarded the failure to make payments as unhelpful to the cause of extension: see email from Mr Anderson (p A351 of Exhibit “C”);

(7) the license was critical to continuation of the right to sell the product;

(8) no evidence of the earlier history of the account (to demonstrate for example that there had always been a long delay in payment);

(9) there was no evidence of industry practice in relation to payment delays in Australia or other countries;

(10) four of the payments were made by Quadtel and not the Company, and no explanation for this was given by the Company.

47 If it were relevant to look only at the last payment (ie 11 April 2003 for $10,000), I think the fact that there were four payments made in March and early April is of assistance to Scansoft, but the fact that a sizeable amount of royalties remained unpaid (see Exhibit “B”) and the other matters referred to above would leave me unpersuaded that there were not grounds to suspect insolvency even at that time.

Conclusion

48 It follows that Scansoft has succeeded on its s 588FA(3) point but not made out a defence under s 588FG(2). Accordingly, there will be judgment for the plaintiffs for $5661.96.

Costs

49 I will hear the parties on the issue of costs.

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