«JUDGMENT No 72 1/@E CATCHWORDS BANKRUPTCY - preference - application by trustee pursuant to s.122 -— payments by bankrupts to creditor within six months prior to presentation of petition - whether payments made in good faith and ordinary course of business - creditor ought to have suspected insolvency and the effect of preference - finding of good faith precluded by s.122(4)(c) - application granted. INTEREST - claim for - whether appropriate where the payments were long overdue and where the payments persuaded the creditor to extend credit - interest refused. Bankruptcy Act 1966, 6.122 Queensland Bacon Pty. Ltd. v Rees (1966) 115 CLR 266 Rees v Bank of New South Wales (1964) 111 CLR 210 C.H. & E. CARR - Bankrupts RODNEY MICHAEL EVANS and MAURICE HODGSON LYFORD as trustees of the property of Colin H. Carr and Eileen Carr, Bankrupts - Applicants ALBANY NOMINEES PTY. LIMITED - Respondent No. 105 of 1983 Morling J. 17 December 1987 Sydney IN THE FEDERAL COURT OF AUSTRALIA ) GENERAL DIVISION ) ) No. 105 of 1983 BANKRUPTCY DISTRICT OF THE STATE ) OF WESTERN AUSTRALIA ) RE: C.H. & E. CARR Bankrupts BETWEEN: RODNEY MICHAEL EVANS and MAURICE HODGSON LYFORD as trustees of the property of Colin H. Carr and Eileen Carr, Bankrupts Applicants AND ALBANY NOMINEES PTY. LIMITED Respondent MINUTE OF ORDER JUDGE MAKING ORDER Morling J. I? December 1987 oo DATE OF ORDER WHERE MADE Sydney ORDERS AND DECLARATIONS AS FOLLOWS: 1. Declaration that the payments made by the debtors to the creditor from 13 May 1982 until 15 September 1982 in the total sum of $31,745.17 constituted a preference, priority or advantage over the unsecured creditors of the debtors and are therefore void against the trustees. 2. Order that Albany Nominees Pty. Limited pay to the trustees of the bankrupt estates of Colin and Eileen Carr the sum of $31,745.17. Costs of the application to be paid by Albany Nominees Pty. Limited. NOTE: Settlement and entry of orders is dealt with in Rule 124 of the Bankruptcy Rules. IN THE FEDERAL COURT OF AUSTRALIA GENERAL DIVISION No. 105 of 1983 BANKRUPTCY DISTRICT OF THE STATE OF WESTERN AUSTRALIA —we we RE: C.H. & E. CARR Bankrupts BETWEEN: RODNEY MICHAEL EVANS and MAURICE HODGSON LYFORD as trustees of the property of Colin H. Carr and Eileen Carr, Bankrupts Applicants AND ALBANY NOMINEES PTY. LIMITED Respondent MORLING J. I] pecember 1987 REASONS FOR JUDGMENT The applicants, who are the trustees of the property of Colin H. Carr and Eileen Carr ("the debtors") seek a declaration that certain payments made by the debtors to Albany Nominees Pty. Limited ("the creditor") constituted a preference, priority or advantage over their other unsecured creditors. The estates of the debtors are being administered in bankruptcy. The petition upon which their estates were sequestrated was presented on 10 November 1982. A payment made by a person who is unable to pay his debts as they become due from his own money in favour of a creditor, having the effect of giving that creditor a preference, priority or advantage over other creditors, being a payment made within six months before the presentation of a petition on which the debtor becomes a bankrupt is void as against the trustee in the bankruptcy: §.122(1) of the Bankruptcy Act, 1966. Sub-section 122(2)(a) provides that the rights of a payee in good faith and for valuable consideration and in the ordinary course of business are not affected by the provisions of sub-s. (1). The burden of proving the matters referred to in sub-s. (2) lies upon the person claiming to have the benefit of that sub-section: s.122(3). A creditor is deemed not to be a payee in good faith if the payment to him was made under such circumstances as to lead to the inference that the creditor knew, or had reason to suspect, that the debtor was unable to pay his debts as they became due from his own money, and that the effect of the payment would be to give him a preference, priority or advantage over other creditors: s.122(4). At all relevant times the creditor carried on business as a fuel agent at Geraldton in the State of Western Australia and the bankrupts carried on business as livestock cartage contractors in that town. On various dates in 1981 and 1982 the creditor sold and delivered petroleum products to the bankrupts at their request. The bankrupts failed to pay for some of the products sold to them by the creditors. The bankrupts' account with the creditor had been in debit for substantial sums since at least August 1981. At the end of that month the account was in debit to the extent of 3. $37,890. The debit balance was $38,927 at the end of September, $35,542 at the end of October, and $35,542 at the end of November. The debtors gave a number of cheques to the amount of about $20,000 to the creditor at the end of 1981 or in the early part of 1982. Initially, this amount was shown in the creditor's accounts as having reduced the debit balances as at the end of December 1981, and January and February, 1982. It seems reasonably clear from the evidence that these cheques were dishonoured by the bank and that they were not re-presented. No doubt because of the dishonour of the cheques the creditor adjusted its accounts so that the debit balance became $37,017 at the end of March 1982. On 15 February 1982 the debtors' solicitors wrote to the creditor stating that the bankrupts were experiencing liquidity problems. After stating that the debtors were anxious to settle their outstanding account as soon as possible the letter continued: "Arrangements have been made to place one of their properties on the market. Expert advice is that, on sale, our clients will receive, nett, in excess of $50,000.00. It is hoped that the property will be sold within the next three (3) months and an agent has been instructed to call for tenders. As you may be aware, the main income period, in our clients' business, is from approx- imately April to approximately November of each year. Our clients' proposition is that they make payment to you of one third of the amount out- standing to you now, by the 31st of May 1982 and let you have a definite proposal as to payment of the balance on or before the 30th of June 1982." 4. The letter further stated that the reason for the debtors' liquidity problem was that they had expended $50,000 to acquire additional equipment and that two of their vehicles had been damaged in accidents, with consequent loss of income. In response to this letter the solicitors for the creditor replied on 8 April stating that it would accept payment of the amount then outstanding ($41,745.17) as follows: "a) The sum of $15,537.35 in a lump sum payment no later than the 31st May, 1982 b) The balance by substantial monthly repayment in a figure to be proposed by your client and agreed by ours to be made for a period of three months when the amount then outstanding is to be paid in full c) Security for payment to be given by your client in the form of a mortgage, such security to be prepared and registered at your client's cost." On 13 May 1982 the creditor issued a writ out of the Supreme Court of Western Australia claiming the sum of $41,745.17 from the bankrupts. Subsequent to the issue of the writ there were discussions between the solicitors which resulted in an agreement being made on 1 June 1982 whereby the debtors agreed to pay the amount of the claim in four instalments, as follows: - $ 15,537.35 immediately; $6,207.82 on 30 June 1982; $10,000.00 on 30 July 1982; and $10,000.00 on 30 August 1982. The first instalment was paid on 31 May 1982. The creditor received two further payments pursuant to the agreement being a sum of $6,207.82 on 21 July 1982 and $10,000 on 2 September 1982. The total of these payments was $31,745.17 and it is this amount which is claimed to have constituted a preference. (There is some slight inconsistency in the evidence as to the exact amounts paid by the debtor and I have adopted the figures most favourable to the creditor.) In April 1982 goods to the value of $1663.94 appear to have been supplied to the debtors, for which they paid cash, leaving the debit balance as at the end of that month unchanged. It thus appears that for nearly nine months prior to receipt of the first payment impugned as a preference the debtors had owed the creditor not less than $35,000. I am satisfied on the evidence that on and after 13 May 1982 the debtors were unable to pay their debts as they became due from their own moneys. I am further satisfied that the payments made by the debtors to the creditor had the effect of giving the creditor a preference, priority or advantage over the other creditors of the debtors. Indeed, counsel for the creditor did not seriously dispute these matters. The substantial question is whether the creditor 1s able to bring itself within the protection afforded by s.122(2) of the Act. The creditor claims that the payments to it were received in good faith and in the ordinary course of business. It is submitted on its behalf that the payments were not made under such circumstances as to lead to the inference that it knew or had reason to suspect that the debtors were insolvent, 6. or that the effect of the payments would be to give it a preference over other creditors. According to Mr Mitchell, a director of the creditor, the debtors had been doing business with the creditor for two or three years prior to their becoming bankrupt. They usually paid their accounts on a ninety day credit basis, and were often slow in paying. However, his experience had been that they always ended up paying their accounts in full. Although he said that none of the debtors' cheques were ever dishonoured, his evidence in this respect appears to be incorrect, since the cheques to which I have referred were never paid by the bank. I accept that Mr Mitchell is a truthful witness, and I conclude that his inaccurate evidence on this matter is occasioned by his imperfect memory of events long since past. Mr Mitchell said that the debtors kept their fleet of trucks and trailers in good condition. He regarded this as an indication that the bankrupts were not in any real financial difficulties, because the first sign of a transport operator being in difficulty was that he ceased properly maintaining his vehicles. After the letter of 15 February 1982 came to his attention Mr Mitchell caused a title search to be made of property owned by the debtors. The search revealed that they had a half interest in a property in Broome, a third interest in some strata lots in Perth upon which factory premises were 7. erected, the home in which they lived in Geraldton and the industrial premises from which they operated their business. The searches revealed that all these interests were mortgaged, but Mitchell said that the fact that there were no second mortgages gave him "a comfortable feeling that the Carrs would be able to pay their debt." In the early part of 1982 other persons issued writs against the debtors. One of these writs was issued by the Commissioner of Taxation and another two by companies carrying on business at Geraldton. Mc Mitchell did not know about these writs and did not hear any rumours suggesting that the debtors were in financial difficulties. Geraldton has a relatively small business community, and Mr Mitchell said that he frequented places where any news of the debtors' financial position would have been mentioned. He said that after his company's writ was served on the debtors, Mrs Carr telephoned him and told him that she thought their solicitor had already communicated with his solicitor and reached some agreement. After the solicitors reached the agreement on 1 June 1982 he took no further action on the writ which had been issued. Mr Mitchell's evidence that the business community in Geraldton was ignorant of the debtors' financial difficulties is supported by Mr Watson, an accountant carrying on practice in Geraldton in 1982, and by Mr McCartney, who was their solicitor and who also carried on practice in Geraldton at that time. 8. On four separate occasions in July, August and September 1982, the creditor delivered fuel to the debtors ona credit basis. The total value of this fuel was $7,382.00 and the creditor has not been paid this amount. It seems unlikely that the creditor would have been willing to give this credit if Mr Mitchell had thought that the debtors were, or were likely to be, insolvent. The crucial question for decision is whether the creditor knew or had reason to suspect that the debtors were insolvent at the time the alleged preferential payments were made. A finding that the creditor did not have actual knowledge nor hold a suspicion of the debtors' insolvency is not determinative of this question. An objective standard must be applied. Knowledge of circumstances from which ordinary men of business would conclude that a debtor is unable to meet his liabilities is knowledge of insolvency: Queensland Bacon Pty. Limited v Rees (1986) 115 CLR 266 at pp.287 and 296 per Barwick C.J. and at p.303 per Kitto J.; Bank of Australasia v. Hall (1907) 4 CLR 1514; National Bank of Australasia v Morris (1892) A.C. 287. The question which falls to be decided is what is the proper inference which a reasonable businessman would have drawn from the facts known to Mr Mitchell, who was in charge of the creditor's affairs. I have reached the conclusion that a reasonable person in the position of the creditor would have suspected that the debtors were unable to pay their debts as they fell due between May and July 1982 when the impugned payments were made. It 9. may be accepted that a trader, to remain solvent, does not need to have ready cash to cover his commitments as they fall due for payment and that in determining whether he can pay his debts as they become due, regard must be had to his realizable assets - see Bank of Australasia v Hall (supra) at p.1543 per Isaacs J.; Rees v Bank of New South Wales (1964) 111 CLR 210 at p.218 per Barwick C.J. But a reasonable person, viewing the facts objectively, must have concluded that the debtors were experiencing more than a temporary liquidity problem. Since at least August 1981 they had been indebted to the creditor for a very substantial sum of money. In succeeding months their indebtedness was only marginally reduced. Early in 1982 several of their cheques were dishonoured. Their solicitor's expectation that their debts could be paid from the proceeds of sale of one of their properties had not been realized. The creditor's requirement that substantial monthly repayments be made after payment of a lump sum of $15,537.35 was not met. No mortgage or other form of security was offered to the creditor. These circumstances, taken in their entirety, ought to have raised in the mind of any reasonably prudent businessman a suspicion that the debtors could not pay their debts as they became due from their own moneys. The dishonour of the cheques, considered in conjunction with the large and longstanding debit balance in the debtors' account with the creditor, ought to have given Mr Mitchell compelling reasons for suspecting that the debtors were insolvent. Dishonour of a cheque which is subsequently re-presented and met by the bank upon which it is drawn may 10. well give rise only to a belief that the drawer of the cheque is experiencing liquidity problems. That was the view taken by the majority of the court in Queensland Bacon (supra) in respect of the dishonoured cheques referred to in that case. But I do not think that such a view is open on the facts of the present case. The debtors' dishonoured cheques were never met. Indeed, although Mr Mitchell's evidence on the point is somewhat confused, it seems reasonably clear that he did not even re-present them to the bank. The most weighty consideration militating against a finding that a person in the position of the creditor would have suspected the debtors' insolvency is that they possessed the interests in the properties to which I have referred. However, Mr Mitchell knew that all those interests were mortgaged. The fact that the debtors had not borrowed additional moneys on the security of those properties for the purpose of paying their debts ought to have led a reasonable person to believe that the debtors' equity in them was insufficient to support further advances. The debtors' failure to deposit sufficient funds in their bank account to avoid their cheques being dishonoured would have led a creditor who turned his mind to the matter to conclude that the debtors were unable to borrow more moneys on the security of their properties, else they would have done so to avoid the embarrassment of the dishonour of their cheques. Further, it seems to me that a person in the position of the creditor, viewing all the facts objectively, must have 11. suspected at the time the impugned payments were made that their effect would be to give him a preference, priority or advantage over other creditors. Even if Mr Mitchell did not actually know of the existence of other creditors he did know, as he conceded in evidence, that the debtors had the reputation of being "slow payers". The debtors were carrying on a substantial business with a turnover in excess of $600,000 per annum. It would have been apparent to any person in the position of the creditor that the debtors almost certainly would be incurring expenses for many items required to carry on that business. Their inability, over such a long period, to reduce their indebtedness to the creditor must have led to a suspicion that there were other creditors whose debts also remained unpaid. In these circumstances, I think that a finding in favour of the creditor under s. 122(2) of the Act is precluded by the provisions of s. 122(4)(c). Whether or not there is any onus on the creditor to disprove the matters referred to in s. 122(4)(c) (as to which see Queensland Bacon Pty Ltd v. Rees (1965) 115 CLR 266 at p.286) and re Bird (as Trustee of the Estate of Arcadiou); ex parte M & G Casabene & Sons (1979) 39 FLR 281 at pp.284-287) I am satisfied in the present case that the matters referred to in s.124(4)(c) have been established. Counsel for the trustee submitted that I should order the creditor to pay interest as from October 1985 on the amount of the preferential payments which it received. It was not 12. argued on behalf of the creditor that the Court lacked power to make an order for the payment of interest in circumstances where the cause of action has arisen prior to the coming into force of s.51A of the Federal Court of Australia Act 1976. Pincus J. has held in Schepis & Ors. v Elders IXL Limited (1986-87) 70 ALR 729 that the Court does have such power. Notice was first given of the trustee's intention to claim interest in October 1985. With some hesitation, I have come to the view that it would not be appropriate to award interest in this case. It is true that the creditor has derived benefit from having been in possession of the amount paid to it. On the other hand, I have little doubt that it was because of the payments made to it that it agreed to supply further fuel to the debtors on a credit basis. This fuel, which was of the value of $7,382.00, was never paid for by the debtors. It seems hard that the creditor should not have been paid for this fuel and at the same time have to pay interest. The amount of the interest sought is about the same as the value of the goods supplied on credit. In cases where preferential payments do not induce ereditors to extend credit to debtors, it will normally be appropriate to order that interest be paid. But in a case such as the present, where the making of the preferential payments led to the creditor worsening its financial position by supplying further goods on credit, I think it is appropriate not to make an order for the payment of interest. I should add that no argument was presented to the Court on behalf of the creditor that the amount which it should be ordered to pay 13. to the trustee should be reduced to take account of the value of the goods supplied on credit. In other words, it was not argued that the payments made by the debtors were made in reduction of their running account with the creditor upon a mutual assumption that there would be a continuance of the relationship of purchaser and supplier between them (cf. Queensland Bacon v Rees (supra)). I make a declaration that the payments made by the debtors to the creditor from 13 May 1982 until 15 September 1982 in the total sum of $31,745.17 constituted a preference, priority or advantage over the other unsecured creditors of the debtors and are therefore void against the trustees. I order the creditor to pay to the trustees the said sum of $31,745.17. The creditor must pay the costs of the application. I certify that this and the twelve (12) preceding pages are a true copy of the Reasons for Judgment of his Honour Mr Justice Morling. Associate: C Motroen Date: Ti 12.1987 Counsel for applicant: Mr M.J. Hawkins instructed by: Messrs McCusker & Harmer, Barristers and Solicitors Counsel for respondent: Mr I. Marshall instructed by: Messrs Altorfer and Stow, Solicitors by their agents: Messrs Northmore, Hale, Davy & Leake, Solicitors 14, Dates of Hearing: 12, 13 November 1987 Date of Judgment: Tt} December 1987