Graham v Pharmacy Wholesalers (Wellington) Limited

[2004] NZCA 326

IN THE COURT OF APPEAL OF NEW ZEALAND

CA37/04

BETWEENGRANT ROBERT GRAHAM

Appellant

ANDPHARMACY WHOLESALERS (WELLINGTON) LIMITED

Respondent

Hearing:11 October 2004

Court:Glazebrook, Hammond and William Young JJ

Counsel:D E Smyth for Appellant

B J Burt for Respondent

Judgment:17 December 2004 

JUDGMENT OF THE COURT

The judgment of Associate Judge Lang is set aside.  The application challenging Mr Graham’s notice is dismissed. There will be judgment in favour of Mr Graham against PWL for the amounts of the various payments together with Judicature Act interest from the various payment dates.  In this Court Mr Graham is entitled to costs in the sum of $6,000 together with reasonable disbursements (including travelling and accommodation expenses if any) to be agreed and, in default of agreement, to be fixed by the Registrar.  Costs in the High Court are to be agreed and in default of agreement fixed by that Court.

REASONS

(Given by William Young J)

Table of Contents

Para No

Introduction   [1]

BACKGROUND - GENERAL

Shannon Pharmacy  [6]

PWL  [11]

The trading history of Shannon Pharmacy  [20]

The view PWL took of the indebtedness to CCL  [25]

Shannon Pharmacy’s insolvency  [42]

Shannon Pharmacy is placed in liquidation  [44]

The payments in issue in the proceedings

The 22 January 1999 payment ($16,600)  [48]
         The 9 February 1999 payment ($26,395.40)  [51]
         The 18 February 1999 payment ($11,3999.40)  [53]
         The 1 March 1999 payment ($26,097.27)  [54]

  The statutory scheme[55][55]

The judgment under appeal  [58]
The issues on appeal  [60]
When PWL received the payments, was it aware   [63]

THAT IT WAS BEING TREATED PREFERENTIALLY?

Were the payments made on 22 January 1999,   [77]
18 February 1999 made by Shannon Pharmacy in the
ordinary course of business?
Is PWL entitled to the discretionary defence   [79]
under s 296(3)?  

RESULT  [80][80]

Introduction

[1]       Shannon Pharmacy Ltd was put into liquidation on 25 July 2000.  The appellant, Grant Robert Graham, was appointed as liquidator on 5 March 2001.  On 27 May 2003, he gave notice setting aside four payments made by Shannon Pharmacy to the respondent, Pharmacy Wholesalers  (Wellington) Ltd (“PWL”).  In doing so, he acted under s 292(2) of the Companies Act 1993 (“the Act”).  The payments in questions were made on 22 January 1999 ($16,600), 9 February 1999 ($26,395.40), 18 February 1999 ($11,399.40) and 1 March 1999 ($28,351.14).

[2]       PWL challenged this notice.

[3]       In a judgment delivered on 5 February 2004, Associate Judge Lang found in favour of PWL. He held that two of the four payments were made in the ordinary course of Shannon Pharmacy’s business (being the payments made on 22 January and 18 February 1999) and that the other two payments (on 9 February and 1 March 1999) were not.  He also held that the discretionary defence under s 296(3) of the Act was made out in relation to all four of the payments.  So PWL was successful in the High Court.

[4]       Mr Graham appeals against that judgment.  He wants all four transactions set aside and a full recovery of the monies paid. 

[5]       PWL does not challenge the finding that the payment on 1 March 1999 was not made in the ordinary course of business.  But it claims that the other three were, and that, in any event, recovery of all payments should be denied under s 296(3) of the Act.

Background - general

Shannon Pharmacy

[6]       As its name suggests, Shannon Pharmacy carried on business as a pharmacy in Shannon.  It purchased that business in March 1996 from the previous owner, CR Collecutt Limited ("CCL").

[7]       CCL had operated a pharmacy in Shannon for many years.  Its principal was and still is Mr Colin Collecutt.

[8]       The agreement for sale and purchase provided for Shannon Pharmacy to pay a total purchase price of $86,200 subject to adjustment for the actual value of stock. Of that sum, approximately $81,000 was to remain owing following settlement. The debt was to attract interest and was to be paid by seven consecutive quarterly payments of $5,000 each, followed by a final payment on 2 March 1998 of all outstanding principal and interest. The debt was guaranteed by Mrs Frost and secured by way of a first-ranking debenture given to CCL over the assets and undertaking of Shannon Pharmacy.

[9]       Shannon Pharmacy also took on lease from CCL the premises previously used by CCL. 

[10]     When Shannon Pharmacy was set up, Mr Collecutt was allocated a 75% shareholding and he was a director. The other director was Mrs Rosemary Frost.  Her husband, Mr Les Frost, is a pharmacist but at the time was an undischarged bankrupt. This meant that he could not participate in the management of the company or own shares in it.  It seems clear that Mr Collecutt’s role was to satisfy the legislative requirements as to the operation of pharmacies and that he did not in reality have any significant commercial interest in the company otherwise than through CCL as a creditor and landlord.  For instance, he never guaranteed the indebtedness of Shannon Pharmacy to PWL.

PWL

[11]     PWL was a co-operative company supplying pharmaceutical products to member pharmacies in the Wellington area.

[12]     Its relationship with CCL began when it entered into a membership agreement with CCL on 13 September 1990.

[13]     Shannon Pharmacy became a member of PWL in February 1996.  Its liabilities to PWL were guaranteed by Mr and Mrs Frost but, as we have noted, not Mr Collecutt.

[14]     PWL would appear to have been the principal supplier of Shannon Pharmacy.

[15]     PWL maintained an active interest in the affairs of Shannon Pharmacy.  PWL received Shannon Pharmacy’s bank statements on a monthly basis and closely monitored its financial performance.  PWL provided reports to Shannon Pharmacy as to its financial position and gave the company a good deal of advice.

[16]     In February 1999, Sigma New Zealand Ltd purchased all the shares in PWL. Sigma New Zealand Ltd is wholly owned by Sigma Company Ltd. 

[17]     In February 2001 Sigma entered into an agreement to sell many of its assets to Zuellig Pharma Ltd.  Included in the sale was the business of (but not the shares in) PWL. That sale was completed on 28 February 2001.

[18]     Pursuant to the agreement for sale and purchase PWL was required to hand over all its records to Zuellig other than those which it was required by law to retain.

[19]     Although Zuellig has provided PWL with copies of some items of correspondence, PWL has no means of knowing whether further documents exist. In addition, Zuellig has now replaced the computer system used by PWL at the time of the transactions. As a result, PWL no longer has access to the computerised records relating to the transactions. Moreover, none of the personnel familiar with the relationship and the transactions with which this proceeding is concerned are still employed by PWL or Sigma.

The trading history of Shannon Pharmacy

[20]     From the outset Shannon Pharmacy encountered difficulties in meeting its obligations both to PWL and to CCL. Its account with PWL fell quickly into arrears, and it was not able to maintain the quarterly payments due to CCL under the agreement for sale and purchase.

[21]     In June 1998, Mr Collecutt resigned as a director of Shannon Pharmacy.

[22]     The lease of the premises expired in April 1999.  In the months leading up to the expiry of the lease, Shannon Pharmacy made no attempt to obtain a new lease. Instead it elected to cease trading on or about 28 February 1999.

[23]     Mr and Mrs Frost set up another company (Shannon Pharmacy Papers and Post Ltd) and caused Shannon Pharmacy to sell its business and assets to that company. The proceeds of sale were used to pay all of Shannon Pharmacy’s creditors other than CCL.

[24]     From what we can tell from the documents, the new company continued trading from the same premises as the old until the lease ran out and then moved to nearby premises.

The view PWL took of the indebtedness to CCL

[25]     From an early stage, PWL was concerned that the indebtedness of Shannon Pharmacy to CCL had the potential to impair Shannon Pharmacy’s ability to meet its obligations to PWL. This concern manifested itself in a good deal of documentation created by PWL.

[26]     In a letter of 5 September 1996 from PWL to Mr and Mrs Frost (which was copied to Mr Collecutt), PWL commented:

… We may have to approach Mr Collecutt to assist with one of the $5,000 loan repayments being deferred, due to the high un-budgeted Repeat File Payments.

[27]     In a letter of 4 March 1997 to Mr and Mrs Frost (which was copied to Mr Collecutt), PWL observed:

… We have noted that you were unable to make full payment on your January purchases during February, due to the large quarterly Loan and Interest payment due to Mr Collecutt on 1 March 1997. …

…

The 1998 Budget shows that you will have Cash Flow problems between June 1997 and October 1997.  This may have to be met by a deferral of both the $4,000 PWL Number 2 account Repayment, and the June $5,000 principal repayment until October/November 1997.

[28]     In a letter of 29 April 1997 to Mr and Mrs Frost (which was also copied to Mr Collecutt), PWL noted:

We have noted that you are continuing to make the $400 weekly payments to the savings account to cover Mr Collecutt’s quarterly repayments.  Please note that this was not included in the 1998 Budget and has resulted in further arrears to our PWL Trading Account, in addition to the second Number 2 account given to your company in January 1997.  … This situation is unacceptable and we request immediate payment of the funds in your savings account of approximately $4,000 and any further funds that may have accrued since your $11,000 payment on the 24 April 1997. ...

This action will allow the option to consider a deferral of your June $4,000 number 2 account repayment in conjunction with further discussions with Mr Collecutt on the possible deferral of the June $5,000 Loan Repayment to December 1997.

(Emphasis as in original)

[29]     In a letter of 10 June 1997 to Mr and Mrs Frost (which was copied to Mr Collecutt), PWL commented:

You have confirmed that Mr Collecutt has already contacted you to request payment of the $5,000 Principal Repayment on due date in June and this has been allowed for by a reduction in the amount of your payment to us in late May.

…

I would … recommend that a meeting be scheduled with Mr Collecutt after your accounts are finalised to discuss the current Cash Position of the Company and also the longer term plans for the final principal and interest payment scheduled for 2 March 1998.

[30]     In an internal PWL memorandum of 12 June 1997, the author noted that there had been an agreement between PWL on an “action plan” which included a commitment by Mr and Mrs Frost to

… [D]efer as many as possible 20th of June payments to pay the maximum amount to PWL. …

The memorandum also noted:

… The repayments to Mr Collecutt are currently placing extreme pressure on their cash flows, with $30,000 repaid to Mr Collecutt in the first 12 months in Loan and Interest repayments and a further $17,000 in Repeat Files which had been claimed in arrears with HBL.  A 10 year loan for $70,000 would certainly alleviate their current cash flow problem.

[31]     A letter of 18 July 1997 from PWL to Mr and Mrs Frost recommended:

… that a meeting be scheduled with Mr Collecutt after your accounts are finalised to discuss the current Cash Position of the Company and also the longer terms plans for the final principal and interest payment scheduled for 2 March 1998.

[32]     In a letter of 15 August 1997 from PWL to the accountants acting for Shannon Pharmacy (and copied to Mr Collecutt), PWL noted:

The result is disappointing when compared to the forecast which showed that our trading account arrears should have been able to be reduced during July, and again in August prior to the next quarterly payment due to Mr Collecutt in September. …

We … request a deferral of the planned $5,000 September Loan payment to Mr Collecutt so that the arrears to our trading account can be reduced to a more acceptable level.

[33]     An internal PWL memorandum of 1 September 1997 referred to a discussion with Mrs Frost:

I also rang Rosemary today to discuss the $5,000 repayment due to Mr Collecutt now.  Rosemary had not heard from Mr Collecutt, but Les and her wanted to make the payment on due date.  I advised that we were not happy with this situation, and PWL was carrying additional arrears to meet Mr Collecutt’s repayments.  I suggest that she should withhold payment until we had the opportunity to discuss the matter with Mr Collecutt.  We should contact Mr Collecutt now to discuss the upcoming repayment and our arrears situation and arrange a meeting date in early October to review the accounts and discuss contingent plans for the final payment on 2 March 1998.

[34]     On the same day PWL wrote to Mr Collecutt recording the request to defer the $5,000 repayment, “to allow our trading account arrears to be reduced” and asking for Mr Collecutt to contact PWL to discuss the situation.

[35]     A letter of 11 September 1997 to Mr and Mrs Frost (which was not copied to Mr Collecutt) referred to a letter of 1 September 1997 to Mr Collecutt and, after noting that PWL had not been able to contact Mr Collecutt, went on:

… We assume that you are still holding the $5,000 principal repayment due in early September to Mr Collecutt in your Bank Account and would request that this be forwarded to us as soon as possible to assist in clearing the above mentioned arrears.

[36]     An internal file memorandum of PWL of 23 September 1997 noted:

… Rosemary advised that following further discussions with Mr Collecutt, $2,500 (50%) had been paid during the month. They currently had $2,500 in their account, and this would be paid to PWL along with any other cash surplus by the end of the month. …

[37]     On 27 February 1998, in a letter to Mr Collecutt, PWL referred to draft accounts for Shannon Pharmacy and went on:

Based on these draft accounts and the cash flow projections to 28 February 1998, Les and Rosemary Frost will be unable to meet the final repayment due to you on 2 March 1998.

The letter proposed a refinancing to be on a first debenture basis (ie in priority to the CCL debenture), a five year extension in relation to money owed to CCL and a reduction in rent.

[38]     The documents suggest that PWL was hopeful that Mr Collecutt would go along with this proposal.  There is a May 1998 internal PWL document which indicates a belief that Mr Collecutt had indeed agreed to do so.  In an unchallenged affidavit, however, Mr Collecutt denied that he had ever agreed to any of the proposals made.  There is no admissible evidence to the contrary.  Further, the fact that Mr Collecutt resigned as a director of Shannon Pharmacy on 12 June 1998, might be thought to have been a clear signal that there was no such agreement.

[39]     On 19 June 1998, PWL wrote to Mr RNH Stockwell, the accountant for Shannon Pharmacy.  This letter was not copied to Mr Collecutt. 

Following Mr Collecutt’s notification to Rosemary that he has resigned as a Director of Shannon Pharmacy Limited, I suggest that we proceed urgently with the loan request to Medical Assurance.  We have enclosed the latest PWL trading account summary and this confirms the continuing progress being made by the pharmacy.  We will have to advise our Board of Mr Collecutt’s resignation as a Director of Shannon Pharmacy.  We request that no further Loan repayments be made to Mr Collecutt until all overdue amounts on the PWL accounts are fully repaid.  We understand that Mr Collecutt remains as the major shareholder with a 75% shareholding and this will only change after the final payment to Mr Collecutt has been made by Les & Rosemary Frost as outlined in the Agreement for Sale and Purchase.  Please advise us if there is any change to this situation.

PWL management are currently of the opinion that the best result for all parties would be to allow the Pharmacy to continue to trade and thereby continue to reduce their debt levels with PWL in the first instance.  Based on the current situation, we believe that Les & Rosemary would have the greatest chance for approval with a loan application for $40,000, as distinct from a full refinancing request for $100,000 with the resulting full and final payment to Mr Collecutt.  A successful loan application would allow the Pharmacy to repay all of the overdue portions of their trading accounts with PWL and allow the Pharmacy to start receiving prompt payment discounts again.(Emphasis added)

There is nothing in this letter to suggest a belief on the part of PWL that Mr Collecutt had agreed to any deferral arrangement in relation to debt owed to CCL.

[40]     No documents of a nature similar to the ones which we have just discussed are available in relation to the period between 19 June 1998 and the beginning of March 1999.  There is, however, no reason to think that the approach of PWL changed.  During this period all indebtedness of Shannon Pharmacy to PWL was cleared.  During the same period, Shannon Pharmacy appears to have been meeting its rent obligations to CCL and to have been current (or reasonably so) as to the interest payments on its indebtedness to CCL.  It did not, however, meet its obligations as to capital repayments and it defaulted on the interest payment due on 2 March 1999.

[41]     It may be of contextual significance to note that Mr and Mrs Frost and PWL believed that the rent payable by Shannon Pharmacy to CCL was excessive.  Mrs Frost said this to the liquidator when explaining the reasons for the failure of the company.  There is an internal PWL note of 1 September 1997 in which the same view is expressed.  There are, indeed, a number of other documents to the same effect: a letter from PWL to Mr Collecutt of 27 February 1998, an internal PWL note as to the 1997 and 1998 accounts and a “rescue plan” prepared by PWL which was premised on a rent reduction.

Shannon Pharmacy’s insolvency

[42]     At all times Shannon Pharmacy was insolvent in the sense that its liabilities exceeded the realisable value of its assets.  Accounts for the period ending February 1998 show a deficit in shareholder funds of over $15,000 despite an allowance for goodwill of $28,000.  Although its financial performance presumably improved during the 1998 calendar year (given that all arrears in relation to PWL were eventually mopped up), there is no reason to suppose that the realisable value of its assets ever reached the point of matching or exceeding its liabilities.  In saying this, we note that Shannon Pharmacy was obviously insolvent when it stopped trading at the end of February 1999.

[43]     Although only limited documents are available for the last seven months or so of the trading history of Shannon Pharmacy, the only sensible inference from the evidence as a whole is that PWL was well aware of the all relevant details of the financial performance of Shannon Pharmacy.  It must, therefore, have appreciated that Shannon Pharmacy was insolvent.

Shannon Pharmacy is placed in liquidation

[44]     In March 2000 CCL served a statutory demand on Shannon Pharmacy seeking payment of the sum of $74,692.97, being the amount then owing under the agreement for sale and purchase and the debenture. Shannon Pharmacy failed to comply with the demand and on 25 July 2000 CCL obtained an order placing the company in liquidation.

[45]     Initially the Official Assignee was appointed as liquidator. In March 2001, however, he was replaced by the respondent in this proceeding, Mr Graham.

[46]     Mr Graham investigated the affairs of Shannon Pharmacy, concentrating in particular on four specific payments it had made to PWL between 22 January 1999 and 1 March 1999.  The liquidator concluded that these payments were voidable in terms of s 292(2) of the Act, and on 27 May 2003 he filed and served on PWL a notice setting aside those transactions.

[47]     At this point in the judgment, it is appropriate to discuss the payments in question.

The payments in issue in the proceedings

The 22 January 1999 payment ($16,600)

[48]     At the end of November 1998, Shannon Pharmacy was in arrears in its indebtedness to PWL by only $2,668.10.  That had reduced from the sum of $19,309.98 as at 31 May 1998. In each of the months between May and November 1998 the arrears had been gradually reduced. Shannon Pharmacy’s ability to reduce the outstanding arrears must have been assisted by its withholding of money which was due to CCL.

[49]     On 1 December 1998 Shannon Pharmacy’s account with PWL was in debit in the sum of $32,455.68. This represented the overdue balance ($2,668.10) together with purchases during November totalling $29,787.58. The total amount outstanding was paid off completely during December by means of three payments of $15,000, $16,000 and $1,500. These payments were made on 14, 29 and 31 December respectively.

[50]     By 1 January 1999 the sum of $29,501.05 was owing in respect of purchases made during the month of December. That sum was paid off by payments of $12,000, $16,600 and $1,000 made on 8, 22 and 28 January respectively.

The 9 February 1999 payment ($26,395.40)

[51]     At 1 February 1999 Shannon Pharmacy owed PWL $26,395.40 for purchases made the previous month. This sum fell due for payment on 20 February 1999.

[52]     This amount was paid on 9 February 1999, approximately eleven days before it fell due for payment.

The 18 February 1999 payment ($11,3999.40)

[53]     This payment was made ten days before 28 February which was when Shannon Pharmacy ceased trading and two days before it fell due for payment.

The 1 March 1999 payment ($26,097.27)

[54]     At 1 March 1999 Shannon Pharmacy owed PWL $26,097.27, representing the cost of purchases during the previous month ($29,011.44) less rebates applied to the account ($2,914.17). This sum would have been due for payment on 20 March 1999. The account was, however, paid in full (and indeed overpaid) by means of a single payment of $28,351.14 made on 1 March 1999.

The statutory scheme

[55]     Section 292 of the Companies Act 1993 is in these terms:

292     Transactions having preferential effect

(1)       In this section, transaction, in relation to a company, means—

…

(e)       The payment of money by the company… .

(2)       A transaction by a company is voidable on the application of the liquidator if the transaction—

(a)       Was made—

(i)At a time when the company was unable to pay its due debts; and

(ii)      Within the specified period; and

(b)      Enabled another person to receive more towards satisfaction of a debt than the person would otherwise have received or be likely to have received in the liquidation—

unless the transaction took place in the ordinary course of business.

(3)       Unless the contrary is proved, for the purposes of subsection (2) of this section, a transaction that took place within the restricted period is presumed to have been made—

(a)At a time when the company was unable to pay its debts; and

(b)      Otherwise than in the ordinary course of business.

(4)       For the purposes of this section, in determining whether a transaction took place in the ordinary course of business, no account is to be taken of any intent or purpose on the part of a company—

(a)       To enable another person to receive more towards satisfaction of a debt than the person would otherwise receive or be likely to receive in the liquidation; or

…

unless that other person knew that that was the intent or purpose of the company.

…

[56]     It is common ground that the relevant transactions were within the specified, but not the restricted, periods referred to in s 292.

[57]     Also material is s 296(3) which provides:

Recovery by the liquidator of property or its equivalent value, whether under section 295 of this Act or any other section of this Act, or under any other enactment, or in equity or otherwise, may be denied wholly or in part if—

(a)The person from whom recovery is sought received the property in good faith and has altered his or her position in the reasonably held belief that the transfer to that person was validly made and would not be set aside; and

(b)In the opinion of the Court, it is inequitable to order recovery or recovery in full.

The judgment under appeal

[58]     In aspects of his judgment which are not challenged, the Associate Judge found that:

(a)All the relevant payments were made by Shannon Pharmacy rather than by its directors.

(b)At the time the payments were made, Shannon Pharmacy was unable to pay its debts.

(c)The payments enabled PWL to receive more towards satisfaction of its debt than it would otherwise have received or have been likely to receive in the liquidation.

[59]     The Associate Judge then addressed the question whether the payments were made in the ordinary course of business.  He concluded that the payments made on 22 January 1999 and 18 February 1999 were made in the ordinary course of business and that the other two payments were not. The Associate Judge then turned to consider the effect of s 296(3) of the Companies Act 1993.  He concluded that in relation to all payments, it was appropriate to allow PWL a defence under this subsection.

The issues on appeal

[60]     PWL no longer seeks to argue that the payment made on 1 March 1999 was made in the ordinary course of business but asserts that all other payments were made in the ordinary course of business.  Mr Graham maintains that all four payments were not made in the ordinary course of business.

[61]     The two primary issues which arise in relation to this appeal therefore are:

(a)Were the payments made on 22 January 1999 and 9 and 18 February 1999 made in the ordinary course of business?

(b)If not, is the s 296(3) defence available to PWL?

[62]     We will address both issues later in the judgment.  But before we do so, we propose to address what we regard as an upstream issue: When PWL received the payments, was it aware that it was being treated preferentially?

When PWL received the payments, was it aware that it was being treated preferentially?

[63]     If this question is answered in the affirmative, it is decisive of the appeal.  As a matter of common sense, and allowing for s 292(4), payments made with an intent to prefer PWL and which PWL knew were made with that intent could not be seen as being in the ordinary course of business.  As well, such payments could not be the subject of the s 296(3) defence.

[64]     It is clear that the Associate Judge considered that the evidence did not establish that PWL was aware that it was being treated preferentially when it received the payments in issue. 

[65]     He dealt with the case on the affidavits and did not hear oral evidence.  So his conclusion was by way of inference largely based on the documents which were placed before him.  His ability to assess those documents was not assisted by the haphazard way in which they were presented to him. The key documents were scattered through the affidavits and not presented in chronological sequence.  They are not dealt with in detail in his judgment.  This is why, earlier in this judgment, we discussed the key documents at such length.

[66]     Because this is such an important aspect of the case we will set out in full the key passage from the judgment of the Associate Judge:

[76]     Good faith in this context requires that Pharmacy Wholesalers demonstrates that it honestly believed that the transaction would not involve any element of undue preference on its part: see Re Orbit Electronics Auckland Limited (1989) 4 NZCLC 65,170 at 65,171 per Casey J.

[77]     There is nothing in the evidence to suggest that Pharmacy Wholesalers did in fact receive preference over other trade creditors, let alone that it knew that it was doing so. The only element of preference arises in relation to the fact that Pharmacy Wholesalers received full payment whilst CCL did not.

[78]     The evidence from Pharmacy Wholesalers is to the effect that there was no information available to it at the time to indicate why Shannon Pharmacy had decided to discontinue purchasing products. Neither was there anything to indicate why Shannon Pharmacy had ceased to trade, especially as the arrears on its account with Pharmacy Wholesalers had by that time been cleared. This latter point is, of course, relevant only to the payment made on 1 March 1999.

[79]     … Pharmacy Wholesalers would, … have been aware that Shannon Pharmacy was not making the quarterly payments of principal it was required to make to CCL under the agreement for sale and purchase and debenture. The issue is whether this knowledge is sufficient to prevent Pharmacy Wholesalers from establishing that it received the payments in good faith.

[80]     In considering this issue it is important to bear in mind that the recipient of the payment is required to demonstrate that it honestly believed that the transaction would not involve any element of undue preference. I have no doubt that if Pharmacy Wholesalers knew that it was being treated differently to other trade or unsecured creditors, it would not have been able to claim that it received the payments in good faith. I consider, however, that the preference which it received over CCL falls into a different category.

[81]     Unlike Pharmacy Wholesalers, CCL had been given security for its debt. This took the form of the first-ranking debenture over the assets and undertaking of Shannon Pharmacy. The debenture provided CCL with access to a wide range of remedies in the event of default by Shannon Pharmacy. It could, for example, have appointed a receiver to take control of Shannon Pharmacy’s assets. It could then have sold those assets not subject to a claim for retention of title and applied the proceeds of sale in reduction of its debt.

[82]     CCL had also obtained a guarantee from Shannon Pharmacy’s sole director, Mrs Frost. This enabled it to pursue her for the entire debt.

[83]     Until 16 June 1998 Mr Collecutt himself was a director of Shannon Pharmacy. To this day he owns 75 per cent of the shares in the company. Mr Collecutt’s position within the company therefore gave him a unique ability to remain fully conversant with both its financial situation and the manner in which it was dealing with all its creditors.

[84]     It is also clear that many of the items of correspondence between Pharmacy Wholesalers and Shannon Pharmacy were copied to CCL (via Mr Collecutt) in its capacity as both landlord of the premises and debenture holder. In particular, during mid-1998 efforts were made to restructure Shannon Pharmacy’s debt to Pharmacy Wholesalers through the provision of finance from an outside lender. It stoutly resisted any suggestion that it should agree to reduce the priority of its security to enable the restructuring to proceed.

[85]     Moreover, CCL was aware from an early stage that the quarterly payments were not being made on due date. By March 1998, when the entire debt ought to have been repaid, virtually the entire principal sum remained outstanding. From mid-1998 to February 1999 CCL remained apparently content to receive quarterly payments of interest alone, and did not press strongly for repayment of the principal sum. It took that stance notwithstanding its awareness of the fact that Pharmacy Wholesalers was adopting a far more rigorous approach to the repayment of the debt owing to it.

[86]     When those matters are considered I take the view that no element of undue preference arises. As at February 1999 Pharmacy Wholesalers is likely to have been aware that CCL was electing to receive the quarterly payments of interest and that these were up to date. CCL had taken no steps to exercise its rights under the debenture notwithstanding that it now says that the floating charge over Shannon Pharmacy’s assets had crystallised in March 1998.

[87]     I consider that by January 1999 Pharmacy Wholesalers was entitled to conclude that CCL was content to receive interest only and to reserve its rights under the debenture and the guarantee given by Mrs Frost. I do not consider that Pharmacy Wholesalers would at that stage have had any cause to believe that it was receiving an undue preference over CCL. I am therefore satisfied that Pharmacy Wholesalers has demonstrated that it received each of the payments in good faith.

[67]     We think that the Associate Judge fell into a number of errors.

[68]     The first was in picking up and applying in a shades of grey way, the phrase “undue preference” from the judgment of Casey J in Re Orbit Electronics Ltd (In liquidation), WH Jones & Co Ltd v Rea.  In that case, Thorp J at first instance used the phrase and this was adopted in this Court by Casey J.  We are satisfied that the phrase was simply intended to refer to a preference which, under the then legislative scheme, was voidable. We doubt that Casey or Thorp JJ contemplated an intermediate class of preferences which, while voidable, were nonetheless not “undue”.

[69]     The second and related error relates to the finding that PWL believed that CCL was content to receive payments of interest only and would rely on its debenture and guarantee from Mrs Frost. 

[70]     As is apparent from what we have said, we can see no evidential basis for any conclusion that there was a formal agreement by which CCL surrendered any of its rights, see [38] above.  We nonetheless accept that CCL appears to have slept on its rights and, during the relevant period, would appear to have been insisting only on payments of interest (and rent under the lease).  Where we differ from the Associate Judge is as to whether this matters.

[71]     There is no evidence that PWL kept Mr Collecutt informed of what was going on (for instance by copying letters to him) after his resignation as a director.  There is no evidence to show that Mr Collecutt was aware of the approach taken by PWL in its 19 June 1998 letter and thus no evidence to show that he was aware that PWL had insisted that all arrears owing to it be paid before he received any payments of principal.  Perhaps more importantly, indolence on the part of CCL could not equate with good faith on the part of PWL except on the shades of grey approach which the Associate Judge took in relation to whether the preferences in favour of PWL were “undue”.

[72]     The Associate Judge was clearly influenced by the forensic disadvantage suffered by PWL due to the lateness of the notice setting aside the payments and the ownership changes in relation to PWL:

[53]     … I bear in mind the fact that Pharmacy Wholesalers has been significantly handicapped in defending this proceeding by events which occurred in February 2001. I shall describe these in greater detail shortly, but the end result is that Pharmacy Wholesalers now has only very limited access to records relating to its dealings with Shannon Pharmacy. There are in fact virtually no records available for the period from June 1998 to March 1999. This means that it is not possible to ascertain with any precision the actual events which led to each of the four payments with which the Court is concerned. The Court must reach its decision based on a broad assessment of the circumstances which pertained between January and March 1999. …

[73]     We accept that PWL has been placed potentially in a position of forensic disadvantage by reason of the delays which have occurred. It is right for allowance to be made for that.  But in the end the decision had to be made on the balance of the probabilities. 

[74]     The conclusion that Shannon Pharmacy set out to prefer PWL over CCL is unavoidable.

[75]     We think that PWL can be regarded as being aware that it was being treated preferentially when it received the payments if it knew that:

(a)Shannon Pharmacy was insolvent at the time of the payments;

(b)It was not meeting its obligations to CCL; and

(c)If Shannon Pharmacy was liquidated, the payments would diminish the pool of funds available for other creditors including CCL.

On our assessment of the probabilities, it is practically inevitable that PWL had knowledge of the three points just referred to. 

[76]     We therefore conclude that when PWL received the payments in question, it knew that it was being treated preferentially.

Were the payments made on 22 January 1999, 18 February 1999 made by Shannon Pharmacy  in the ordinary course of business?

[77]     The finding we have made in the preceding section of this judgment answers this question in favour of Mr Graham.   It is, however, worth mentioning briefly the circumstances surrounding each of the payments.

[78]     The payment on 22 January 1999 was for a lump sum.  The payments on 9 February was obviously out of the ordinary given that it was paid 11 days early. The payment on 18 February, which was made two days early and within 10 days of the new company taking over, can only sensibly be seen as part of the wind-down by Shannon Pharmacy of its business.  These payments preceded the final and quite extraordinary payment made on 1 March 1999 which itself might be thought to cast something of a shadow over the validity of the earlier payments.

Is PWL entitled to the discretionary defence under s 296(3)?

[79]     The findings we have made as to absence of good faith on the part of PWL mean that we must resolve this question in favour on the appellant and, that being so, there is no point in dwelling on this issue.

Result

[80]     The appeal is allowed. 

[81]     The judgment of Associate Judge Lang is set side.  The application challenging Mr Graham’s notice is dismissed. There will be judgment in favour of Mr Graham against PWL in the amounts of the various payments together with Judicature Act interest from the various payment dates. In this Court Mr Graham is entitled to costs in the sum of $6,000 together with reasonable disbursements (including travelling and accommodation expenses if any) to be agreed and, in default of agreement, to be fixed by the Registrar.  Costs in the High Court are to be agreed and in default of agreement fixed by that Court.

Solicitors:
Stephen McDonald, Auckland for Appellant
Chapman Tripp, Auckland for Respondent