Unfair preferences and insolvent transactions – ‘knowledge’ of insolvency and the good faith defence

In Stimpson v Commissioner of State Revenue [2018] QDC 140, the District Court of Queensland considers the statutory defence under the Corporations Act 2001 (the Act) to preference or insolvent transaction proceedings. Underlying the decision is the impact increasingly automated processes may have on well-established legal principles regarding evidence of ‘knowledge’ and ‘belief’. This contributed to the Office of State Revenue (the OSR) successfully defending the proceedings.

What happened?

State Wide Trades and Labour Hire Pty Ltd (the Company) was 1 of a group of 12 related companies which were grouped for payroll tax purposes. Under the Payroll Tax Act 1971 (Qld), each member of the group became liable to discharge the payroll tax obligations of any group member.

Another company within the group was placed into voluntary administration.  That related company had an outstanding tax debt exceeding $100,000. Proceedings were commenced against the Company and 3 related companies within the group in respect of that payroll tax debt.

The OSR, to whom the tax debt was payable, used a computerised system (known as a revenue management system (the RMS)) as part of its recovery processes. The RMS issued reminder letters and letters of demand automatically such that the failure to pay payroll tax would not ordinarily come to the attention of an OSR collections officer until 14 days after the demand (approximately 6 weeks after the initial default). Click here to read more. 

Prior to March 2013, the Company generally paid its payroll tax either on time or early.  However after March 2013, this was not the case. The standard letters were issued by the RMS and direct contact had been made by OSR collections officer(s). Relevantly, between July and September 2013 the Company made 4 payments totalling approximately $173,000 to the OSR.

In October 2013 the Company was placed into liquidation. Subsequently, the Liquidators brought these proceedings seeking to recover as preferences or insolvent transactions the 4 payments of payroll tax made to the OSR pursuant to section 588FF of the Act.

What the Court considered

The OSR admitted that the Company was insolvent when the payments were made and that the OSR had received more than it would have received by way of dividends in the liquidation of the Company if it had proved as an unsecured creditor.

As such, the matter turned on whether the OSR could establish the statutory defence under section 588FG(2) of the Act, that is:

• The OSR became a party to the transaction in good faith;
• It subjectively had no reasonable grounds for suspecting the Company was insolvent at the time, or would become insolvent by making the payment; and
• Considered objectively, no reasonable person in the OSR’s position would have suspected insolvency.

Judge McGill described the test as a demanding one, because the OSR was required to prove a negative.

The Liquidators opposed the defence, relying on the Company’s payment history and information which was available to the OSR about the Company’s financial position.

In considering the defence, his Honour stated that it was somewhat artificial to speak of the “controlling mind” of the OSR because the OSR’s engagement with the Company was undertaken by OSR officers who were essentially applying standard procedures in a mechanical way.

Judge McGill considered that the pattern of payments made by the Company suggested a temporary lack of liquidity, rather than insolvency. Further, whilst a proceeding had been commenced against the Company regarding tax liabilities of a related company, the proceeding was at an early stage. The default judgment was signed the day prior to the last payment – His Honour considered that there was insufficient time for such a failure to respond to that Judgment to be suspicious. Finally, Judge McGill considered that the position was less suggestive of insolvency as time went. This was in part due to the fact that the Company’s payments were becoming “less late”.

Judge McGill held that an ordinary business person would not have suspected actual insolvency. As such, the OSR successfully made out the defence in respect of all payments and the Liquidators’ claim was dismissed.

Why is this case interesting?

The Liquidators faced an evidentiary challenge because, in reality, there was no actual OSR officer to question regarding whether that officer considered the Company was insolvent whilst the RMS undertook its automated processes. One could not question the RMS as to whether it thought the Company was insolvent. This inevitably impacted the OSR’s “knowledge” and “belief” about various matters, but key to this case was whether the OSR knew or ought to have known that the Company was insolvent.

Participants in diverse industry sectors are increasingly implementing automated systems to perform functions such as the accounts receivable/collections roles. The question of knowledge in similar circumstances will likely become more common.

Key takeaway

This case serves as a useful reminder to go back to basics – when considering an unfair preference claim; practitioners ought to turn their minds to the available defences.

Given that automated systems are only becoming more prevalent, industry participants should consider how technology will impact the evidentiary hurdles that might arise as this could ultimately “make or break” your case.

Authored by:
Scott Couper, Partner
Tahlia O’Connor, Associate