JUDGMENT
1 HIS HONOUR : This is a case stated by a local court magistrate hearing a civil claim by the defendants Messrs Rodgers and MacDonald, the liquidators of Cypain Pty Ltd (Cypain) to recover alleged preferences. The claim made in the local court was that the present plaintiff had received preferential payments totalling $32,933.52 from Cypain. The learned Magistrate found for the defendants and entered judgment for $44,658.85 which included $8,253.33 interest and $3,300 for costs and disbursements.
2 The plaintiff duly requested the learned Magistrate to state a case, which she did. The case shows that the principal complaints made by the plaintiff are that her Worship completely misunderstood the test she was to apply and further that she misunderstood the principles applicable as to whether or not there was a running account between the plaintiff and Cypain at the relevant time.
3 Both counsel for the plaintiff (Mr J E Thomson) and the solicitor for the defendants (Mr S Gallant) agree that the learned Magistrate completely misunderstood the applicable law on the first point. Indeed Mr Gallant submits that Mr Thomson's submissions to this Court, which I will set out shortly, are an admirable exposition as to what the correct principles are. This is really no surprise because both gentlemen put exactly the same submissions to the learned Magistrate both orally and in writing. Both submitted that the Court must apply the "commercial reality" test mentioned by McGarvie, J in Taylor v Australia and New Zealand Banking Group Ltd (1988) 13 ACLR 780, 784 and expounded in more detail by myself in Hamilton v BHP Steel (JLA) Pty Ltd (1995) 13 ACLC 1548. Her Worship decided to treat the latter decision as "obiter" and so not binding on her, declined to accept the help provided to her by the common submissions of the learned and experienced lawyers who appeared before her and put up her own test contrary to a consistent line of decisions of the High Court, this Court and other Supreme Courts over the last 40 years.
4 I have remarked elsewhere that preference claims under $40,000 should be heard in the local court. If the present case is anything to go by, it is disturbing to see that parties are unable to get a rational decision and are forced to the expense of having a small claim entertained in this Court with all the added expense. In saying this, I am not denigrating the learned Magistrate. A judicial officer soon learns not to trust every submission of every lawyer who appears in his or her court. However after hearing a sufficient number of cases, one learns who knows what he or she is talking about and whose submissions must be treated with suspicion. I suspect at least part of the problem is that the Magistrate did not have a sufficient bulk of this type of case to know to what extent she could rely on the advocates and felt she had to do her own research into a technical and complex area of the law, which research miscarried.
5 The concession that the learned Magistrate applied the wrong test is enough for me to decide that the Magistrate erred in law and return the case to her for determination according to law.
6 However, both advocates ask me not to sent the case back. Both say the primary facts as they were presented to the Magistrate are not in dispute and that with one possible exception, there is no question of credibility to be considered.
7 Mr Thomson says that s 106 of the Justices Act 1902 as amended, especially sub-section (1)(c), gives the Court wide powers to make such order as it thinks fit including an order that the Court itself enter judgment for one or other of the parties.
8 Mr Gallant consents to this Court making a final determination because this relatively small matter is the last matter to be dealt with before the liquidators can apply to have the company dissolved. The liquidators consider it in the interests of creditors generally that that happen sooner rather than later.
9 The almost invariable order when a magistrate is wrong on a point of law is to answer the magistrate's question "Yes" and remit the matter to be heard according to law: Toohey v Taylor [1983] 1 NSWLR 743, 751. However, there is power for this Court to enter its own judgment being the judgment the magistrate ought to have entered. The only precedent for this type of order that I have been able to find is Barton v Elliott (1887) 3 WN (NSW) 110, where the Full Court found that the magistrate had completely misunderstood a plain tenancy case and that the only order that could be made was that the landlord have possession and the Court so ordered.
10 Thus there is power under s 106 of the Justices Act to make a final order in this case. However, to minimise the danger of people asking this Ccourt as a matter of course to do this, I should state that the Court will probably only so deal with a case stated in special situations. The factors that to my mind make the present a special situation are that both parties consent, the matter is a non-criminal case and the principal question is a question of law and the factual matters can be decided by reference to the materials before the Court without making any findings as to credit.
11 I now embark on a consideration of the merits of the matter. I must note that I only have to deal with two matters as the remaining aspects of the case, including some statutory defences raised by the present plaintiff before the Magistrate, were rejected by her and are not the subject of the case stated.
12 THE PREFERENCE QUESTION
As I remarked earlier, both advocates agree that Mr Thomson's submissions correctly state the law on the test for a preference. I agree and will now set out the essentials of those submissions. This is made easier for me because, in accordance with modern practice, Mr Thomson supplied his submissions both on disk and in hard copy so that they can easily be incorporated into the reasons that I am myself composing on my computer.
13 Section 95A(2) of the Corporations Law provides that a person who is not solvent is insolvent and s 95A(1) provides that a person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable.
14 This definition in substance merely restates the applicable test which had previously applied under s 565 of the Corporations Law, picking up as it did the operation of s 122 of the Bankruptcy Act 1966, (in its former incarnation).
15 Thus, Sandell v Porter (1966) 115 CLR 666, and in particular the observations of Barwick CJ at 670 continue to be regarded as a correct description of what must be shown to prove insolvency. For example, in Ford's Principles of Corporations Law (1994, Butterworths, Sydney) [20.140] ("Proof of Insolvency When the Debt was Incurred") the learned author states:
"The s 95A test requires an ascertainment of the company's existing debts, its debts within the near future, the date each will be due for payment, the company's present and expected cash resources and the date each item will be received. The court's task is to decide whether the company is suffering from a temporary lack of liquidity in which case it is not insolvent (Bank of Australasia v Hall (1907) 4 CLR 1514; Sandell v Porter (1966) 115 CLR 666, 670) or an 'endemic shortage of working capital': Hymix Concrete Pty Limited v Garrity (1977) 13 ALR 321, 328".
16 The cases decided after the introduction of s 95A and the revised preference provisions, are to the same effect. In Downey v Aira Pty Ltd (1996) 14 ACLC 1068, 1070-1, Ashley J said:
"In concluding that Taylor Grace was insolvent at the relevant times I have not applied the test of solvency set up by s 95A(1) in an entirely literal and mechanical way. It would be wrong to conclude that a company was insolvent on a given day only because, on that day or for some short period thereafter, the company was unable from readily available liquid assets to pay its debts as and when they fell due and payable. Cases decided in the context of the former Companies Code, which imported s 122 of the Bankruptcy Act 1966 (Cth) remain pertinent, notwithstanding that the language of s 122(4)(c)(i) somewhat differed from the present legislation: see for example the judgment of Barwick CJ in Sandell v Porter and Anor (1966) 115 CLR 666, 670, cited by McGarvie J in Taylor v Australia & New Zealand Banking Group Limited (1988) 6 ACLC 808, 810-811. In Taylor (at 810) McGarvie J described determination of the issue as a 'question of fact to be decided as a matter of commercial reality in the light of all the circumstances'. The concept of 'commercial reality' was explored by Young J in Hamilton v BHP Steel (JLA) Pty Ltd (1995) 13 ACLC 1548".
Ashley J quotes with evident approval, passages from Young J's decision in Hamilton v BHP.
17 The Full Court of the South Australian Supreme Court in Sims v Celcast Pty Ltd (1998) 71 SASR 142, 147, stated that "Insolvency is a question of fact to be decided as a matter of commercial reality in light of all the circumstances: see Taylor v Australia & New Zealand Banking Group Ltd (1988) 6 ACLC 808." Williams J (with whom Cox J and Mullighan J agreed) also set out the passage from Barwick CJ in Sandell v Porter as clarifying the meaning of "solvent" for the purposes of s 95A of the Corporations Law. The "post Harmer" provisions for voidable transactions were being applied in that case.
18 In Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 13 ACLC 823, 832, Lindgren J stated:
"Section 95A of the Law states a 'cashflow test' rather than a 'balance sheet test' of insolvency."
19 Under s 592(1)(b) of the Law, liability could be incurred when there are reasonable grounds to expect the phrase used is "that the company will not be able to pay all its debts as and when they become due". In Re New World Alliance Pty Limited (Receiver and Manager Appointed); Sycotex Pty Ltd v Baseler (1994) 51 FCR 425, 435-6, Gummow J noted:
"At the trial, a great deal of attention was focused on the level of indebtedness of New World and whether its liabilities exceeded its assets. However, this in itself does not directly answer the issue raised by par (b). The issue is not dealt with by analysing a hypothetical instantaneous liquidation: see Dunn v Shapowloff [1978] 2 NSWLR 235, 244 per Mahoney JA … If debts are long term, and the company is making profits, it may be that a company with a substantial indebtedness could trade its way out of difficulties. What is required is an analysis of the assets and financial resources of the company, and its likely liabilities and probable dates that these will fall due, to ascertain whether it is reasonable to expect that one or more of these liabilities will not be able to be met."
20 Mr Thomson then put that on the facts before the Magistrate, the liquidators had failed to show that Cypain was insolvent on a cashflow basis at any of the relevant dates. The payments under attack were made between 10 February and 2 June 1995. Cypain's balance sheet and profit and loss accounts as at 30 June 1994 or at 31 March 1995 were in evidence. Mr Thomson puts that on both the lastmentioned dates, Cypain's enterprise was a going concern. He points to the fact that in the year ended 30 June 1994, Cypain traded at a profit of $27,780 even after bringing into account non-cash charges including amortisation - intangibles $12,535 and depreciation $17,662. Trade creditors at $265,371 had not materially increased from the previous year and there was no evidence to suggest that they were not able to be paid out of current assets totalling $445,489. The bank overdraft and bank loan which were included in current liabilities had reduced over that year and although the overdraft was on demand it was subject to annual review, the other loans were payable on or before 14 May 1995 and subject to annual review. The evidence was that all bank facilities were in fact refinanced in March/April 1995. The other liabilities were to the directors and their family trust who continued to support the company. So, he puts, the 30 June 1994 accounts certainly failed to establish that Cypain was insolvent on a cashflow basis.
21 Then turning to the profit and loss account for the nine months ended 31 March 1995, Mr Thomson submits that although these disclosed a net loss of $26,790 which, after allowing for non-cash items amortisation - intangibles $9,402 and depreciation $10,557, all that they indicated in commercial terms was that Cypain required additional cash of $6,831 to fund the trading loss. The company's bank loans had been refinanced and $238,000 was now shown as non-current. The notes showing the details of the 31 March 1995 summary accounts were not proved. Mr Rodgers, one of the liquidators gave evidence before the Magistrate and, in cross-examination, said that he did not know where the notes to the accounts for 31 March 1995 were. Mr Thomson put that it is significant that Mr Rodgers did not suggest they were unavailable. Mr Rodgers agreed that the 1993 and 1994 accounts did not show any significant trading loss in those two years and that non-cash items and things of that nature should be ignored for purposes of assessing demands on the company's cashflow. Mr Rodgers agreed with counsel that Cypain lost the support of its previous banker (ANZ) around December/January 1995 and arranged for a refinancing of those facilities with a new banker prepared to support the company with banking facilities. He also agreed that Cypain continued to enjoy the confidence of its incoming or new banker until close to liquidation.
22 Mr Thomson thus puts that the summary accounts of 31 March 1995, without the accompanying notes do not prove that Cypain was insolvent on a cashflow basis on 31 March 1995.
23 Mr Gallant puts a different view of the accounts. He says that as at 30 June 1994, Cypain had accumulated losses of $138,102. Its sales had fallen by 8% compared with the previous financial year. Its turnover and consequently its business, had suffered a downturn. If one compares the current assets with current liabilities, it is clear that 61% of current assets was constituted by stock. The evidence of Mrs Morton, the plaintiff's executive director was that when she spoke to Cypain's accountant on 30 March 1995, he remarked that part of the problem was high stock levels creating cashflow difficulties. Mr Gallant puts that the commercial reality of the situation was that, as at 30 June 1994, the company would have had to liquidate all its stock to meet its current liabilities, which it could not do.
24 Then Mr Gallant says that, having established that Cypain was insolvent as of 30 June 1994, the defendants can rely on the presumption in s 588E(3) of the Corporations Law.
25 Alternatively, the accounts of 31 March 1995 show a loss for the period, a further reduction in sales, a reduction in stock levels and a reduction in receivables disclosing an effort to collect trade debts. Although there had been refinancing, the figures show a decline in Cypain's position and demonstrate that it was unable to meet its debts as and when they fell due.
26 It is clear that Cypain was not in the best of financial health at the relevant time. It is also important to remember that the onus is on the liquidators to demonstrate insolvency. With this background, the question I need to decide is whether that evidence of unhealthiness was merely a temporary lack of liquidity (in which case it is not to be classed as insolvent) or an "endemic shortage of working capital" which would indicate insolvency.
27 In addition to the factors to which the advocates have directed my attention, the evidence before the learned Magistrate shows that no goods were supplied by the plaintiff to Cypain between 16 March 1995 and 2 June 1995 despite orders being placed. Orders were only met after Cypain little by little reduced its accumulated time of indebtedness to below 30 days. Ordinarily, the plaintiff was tolerant of debtors up to 45-60 days. Again, when Mrs Morton spoke to Cypain's accountant as set out earlier, the accountant informed her that, "No one is owed for amounts further back than December 1994". This at least means that there were some creditors whose debts were at least three months old. However, Cypain's former bank had withdrawn its support in December 1994/January 1995 and the new financial arrangements were not finally put into place until, it would seem, the first week of April 1995. This would blunt the signifiance of some creditors having to wait 100 days for payment instead of the usual trade terms of 30-60 days. Again Mr Rodgers conceded that it would appear that the cashflow position was about line ball between June 1994 and March 1995. In this period, as I have already remarked, there had been no material increase in the level of trade creditors.
28 Further, there was evidence which was not contradicted that in the packaging trade, particularly in Canberra where Cypain was based, there is a considerable slow period during Christmas/January.
29 Although the case is close to the borderline, my view of the evidence is that by February 1995 Cypain was in greater financial trouble than mere cashflow. Even in mid 1994, the basic position was that Cypain had accumulated losses and its principal current asset was its stock. Stock levels had remained high and constant from 30 June 1993. It had trade creditors of $265,000 and the only current funds to pay them could come from receivables and from bank funding. The business was obviously falling off after 30 June 1994 and the only way it was being kept afloat was by a further bank loan supported by injection of funds from the directors' superannuation accounts. The problems were exacerbated by the refinancing needed in early 1995 and Cypain got further and further behind with its payments to the plaintiff and by March that year had trade debts of 100 days old. Its asset position was deteriorating at least slightly, its turnover was down and it was still making losses. By February 1995 it was insolvent.
30 I thus need to turn to the question as to whether there was a running account.
31 THE "RUNNING ACCOUNT" ISSUE
This matter is significant because in fact the evidence showed that between 10 February 1995 and the commencement of the insolvent administration (the period over which the payments totalling $32,933.52 claimed by the liquidators were made), the plaintiff supplied further goods on credit totalling $27,950. Thus, any preference affected through the running account, was less than $5,000.
32 Section 588FA(3) of the Corporations Law is a statutory embodiment of what was formerly referred to as "the running account doctrine": Olifent v Australian Wine Industries Pty Ltd (1996) 14 ACLC 510, 517.
33 The evidence before the learned Magistrate was that the transactions which led to the payments being made by Cypain were all of a similar type, were all on the one account and were all part of a continuing business relationship.
34 In Airservices Australia v Ferrier (1996) 185 CLR 483, 504-6, the majority in the High Court confirmed that "The essential feature of a running account is that it predicates a continuing relationship with debtor and creditor with an expectation that further debts and credits will be recorded. Ordinarily, a payment, although often matching an earlier debit, is credited against the balance owing in the account." The majority adopted the approach taken by Barwick CJ in Queensland Bacon Pty Limited v Rees (1966) 115 CLR 266, 283-6.
35 The operation of the running account principle was reviewed by the Court of Appeal in Panasonic Australia Pty Limited v Wily (1997) 15 ACLC 613. Mr Thomson puts that this is in accordance with the principles for which the plaintiff contends in the instant case. Sheller JA in the Panasonic case at 616-8 explained the underlying purpose of the rule saying:
"To the extent that the payments received between these dates reduced this debt, they had the effect of giving Panasonic a preference priority or advantage over Mistmorn's other creditors. By contrast, to the extent to which the payments were received to maintain the supply of goods in the course of continuing the business, they did not have the effect of giving Panasonic a preference. That this is so is demonstrated by the High Court's parable in Richardson v The Commercial Banking Co of Sydney Limited (1952) 85 CLR 110, 133 that:
'a running account of any debtor who has reached insolvency must present difficulties under s 95 [the equivalent of s 122]. A debtor who pays something off his grocer's account in order to induce the shopkeeper to give him further supplies of groceries can hardly be held, as it seems to us, to give the grocer a preference, if that was the clear basis of the payment. If the grocer credited the money as a payment for the future deliveries instead of the past deliveries of groceries he would in the end be in exactly the same position and yet he could not be attacked as having received a preference.'"
36 In Airservices Australia v Ferrier (supra) at 503-4, Dawson, Gaudron and McHugh JJ emphasised that in assessing alleged preferences through a running account, the Court looks beyond the immediate effect of payment as a reduction of past indebtedness:
"Like the case of the wider transaction, s 122 does not require the court to look at the immediate effect of a particular payment if 'the payment formed an integral step in a unified course' (Rees v Bank of New South Wales (1964) 111 CLR 210, 222) of dealings between the parties. The court looks to the business effect of the parties' dealings which almost invariably proceed on the understanding, sometimes expressed 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.
"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, eg, CSR Ltd v Starkey (1994) 13 ACSR 321, 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] Arg LR 654; CSR Ltd v Starkey (supra)). 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 at 659-661)".
37 Mr Thomson also relied on the decision of the Victorian Court of Appeal in Sands & McDougall Wholesale Pty Ltd (In Liq) v Commissioner of Taxation [1998] VSCA 76, which concluded at [43] with the definition that "a continuing business relationship involving a running account would ordinarily be expected to involve at least two parties linked by contract, one supplying goods or services to the other on a credit basis, the other paying on a continuing basis, both to extinguish past liability and to ensure continuance of supply."
38 Mr Thomson puts that the commercial arrangements between Julzar and Cypain as disclosed on the uncontested evidence and accepted by the learned Magistrate, had precisely those characteristics. He puts that there was uncontested evidence from Mr Murphy, the plaintiff's NSW Manager, that Cypain was a customer of the plaintiff from about January 1990 until June 1995. Throughout that period, the plaintiff afforded credit to Cypain upon the basis that Cypain maintained its account in order and that if the account exceeded 45 days in arrears, supply of product would be withheld until the then outstanding account or accounts had been paid. This occurred on several occasions during the trading relationship followed by a resumption of supply once the necessary payments had been made. The course of dealings demonstrates that the long-standing commercial relationship was continued through the relation back period, and involved a mutual assumption of further supply on credit under the credit terms arrangements. That is demonstrated by the resumption of supply on 2 June 1995, the same day Cypain brought its account within the plaintiff's credit terms.
39 Mr Thompson then puts that the liquidators' submission (which the learned Magistrate accepted) that business arrangements cannot constitute a running account if they involve the suspension of supply on credit until the account is brought back to order, cannot be correct. That is the very situation which the High Court's parable about the grocer identifies. The payment of the account is necessary to induce the grocer to allow further supply on credit. The very basis of their commercial relationship is that until the payment is made further supplies will not be released.
40 Mr Gallant does not disagree with the most part of Mr Thomson's exposition of the law which I have summarized above. However, he says -
(1) In the present case there has not been continuity of payments and supply as required by the authorities;
(2) The learned Magistrate found as a fact that there was no ongoing business relationship at the relevant time;
(3) There was no intention shown in the plaintiff to continue supply during the relevant period (vide CSR Ltd v Starkey (1994) 13 ACSR 321, 324);
(4) In any event, apart from the payment of $7,310.49 on 10 February, 1995, there was no supply of goods for the period of 3 April to 2 June, 1995 when all the remaining payments attacked as a preference were made.
41 In my view I should accept most of the defendants' submissions. It would have been preferable for the learned Magistrate to have set out in the stated case that she had found that there was no ongoing business relationship at the relevant time. However, the passage at page 10 of her judgment, page 228 of the case makes it clear that she did so. She set out the present defendants' submission that she should accept Mrs Morton's evidence as showing clearly that the present plaintiff's attitude towards Cypain was that there was no ongoing business relationship until Cypain's account was brought within terms, that is that all moneys owing were paid. Thus there was not the factual basis for a running account from at the latest 1 April 1995 as there was not the "intention of continuing supplying the company on credit" (CSR v Starkey (supra) at p 324).
42 However, when one examines the evidence of Mrs Morton, it can be seen that the plaintiff only changed its attitude to Cypain after the bounced cheque episode and her conversation with Cypain's accountant on 30 March 1995. Up until then, the dealings between the parties have all the indicia of a running account; the fact that supply is withheld until the account is brought within trading terms does not affect the relationship until the point is reached, as it was by 30 March 1995, that everything must be paid before any further supply is made and an appreciable period elapses before supply is resumed.
43 The result is that this defence reduces the amount of the liquidators' verdict by $7,310.49.
44 Thus the Magistrate's question should be answered, "Yes". She should also be advised that she should, in the light of these reasons and by consent of the parties, amend her judgment for the present defendants to $25,623.03 plus the appropriate amount of interest and costs.
45 I will stand the matter over for short minutes to be brought in by the plaintiff. Those short minutes will need to be carefully framed in view of the fact that what is happening here is that the decision on the merits is a matter of record in the local court. As to costs, I would have thought that the costs of the first trial would have abided the result of reconsideration by the Magistrate after the case was returned to her. Because of the procedure I have adopted the notional retrial favoured the present defendants so that the original order for costs made by the Magistrate should stand. As the plaintiff has succeeded on the only legitimate question before the court, that is whether the Magistrate erred, it should not pay any costs of the appeal. However, as the plaintiff was only slightly successful on the merits, my present view is that each party should bear its own costs of the appeal. I have not yet heard counsel on this matter. Either party may argue the correctness of my preliminary view when the short minutes are brought in without being thought to be guilty of disrespect to the Court.
46 I will formally stand the matter over to 31 March, 1999 at 9:50am for the purpose of dealing with draft short minutes of order. If that time is inconvenient to the advocates, they may, at least the week before, arrange a substitute day with my Associate.