Plaintiffs v Defendant

CORPORATIONS - Set-off provisions - What constitutes notice of fact of debtor's insolvency - s 553C(2) Corporations Act 2001.

Airservices Australia v Ferrier (1996) 185 CLR 483

Austin Australia Pty Ltd v De Martin and Gasparini Pty Ltd [2007] NSWSC 1238

Barnes v Addy (1874) LR 9 Ch App 244

BP Australia Ltd v Brown [2003] NSWCA 216; (2003) 58 NSWLR 322

Cavenett v Commonwealth [2007] VSCA 88

Crema v Land Mark [2006] VSC 338; (2006) 58 ACSR 631

D'Aloia v Commissioner of Taxation of the Commonwealth of Australia [2003] FCA 1336; [2003] 203 ALR 609

Dowling v Bowie [1952] HCA 63; (1952) 86 CLR 136

Farah Constructions v Say-Dee Pty Ltd [2007] HCA 22; (2007) 230 CLR 89

Gye v McIntyre [1991] HCA 60; (1991) 171 CLR 609

JLF Bakeries Pty Ltd (in liq) v Baker's Delight Holdings Ltd (2007) 25 ACLC 1164

Law v James [1972] 2 NSWLR 573

Re A & J Lazzarotto Pty Ltd (Unreported, Full Court of the Supreme Court of Victoria, Young CJ, Lush and Fullagar JJ, 16 December 1977) (judgment annexed)

Re Deveze; Ex parte Barnett (1874) 9 Ch App 293

Richardson v Commercial Banking Co of Sydney [1952] HCA 8; (1952) 85 CLR 110

Sandell v Porter [1966] HCA 28; (1966) 115 CLR 666

Thomas v Hatzipetros (1997) 24 ACSR 286 (SCNSW)

V R Dye v Peninsula Hotels [1999] VSCA 60; [1999] 3 VR 201

1 The first plaintiff, Jetaway Logistics Pty Ltd (receivers and managers appointed) (in liquidation), carried on a trucking business based at Castlemaine. It incurred tax liabilities to the Commissioner of Taxation for GST, Pay As You Go withholding tax and fringe benefits tax.

2 The Australian Tax Office kept a single account of these taxes for the taxpayer. It was debited and credited with taxes incurred, payments made and GST credits. Until November 2003, Jetaway's account was in order, but in late 2003 it fell into arrears. The arrears came to the attention of the Debt (Campaigns) section of the ATO in Adelaide. This section chases up late payers and is authorised to enter into arrangements to allow businesses having difficulty making payments to meet their tax liabilities. During 2004, the section made four such arrangements with Jetaway.

3 As a major user of diesel fuel, Jetaway was entitled to diesel fuel grants under a Commonwealth scheme administered by the Commissioner. The Commissioner permitted taxpayers entitled to the grant to offset the entitlement to the grant against tax otherwise due to the Commissioner. After making two arrangements to defer payment of tax owing to the Commissioner, the section suggested, and Jetaway agreed, to apply their monthly diesel fuel entitlement in payment of its accrued tax liability of some $215,000. Accordingly, six set-offs totalling $875,540.06 were made between 18 March 2004 and 31 August 2004. Jetaway went into voluntary administration on 6 September 2004.

4 The second and third plaintiffs, the liquidators of Jetaway, claim that the satisfaction of tax owing by Jetaway by the six set-offs constitute unfair preferences. The liquidators say that Jetaway was insolvent as at 12 February 2004 and at the date of each set-off transaction. The Commissioner does not dispute the allegation of insolvency.

5 The Commissioner says that each of the set-off transactions did not constitute a preference as under s 588FA the transaction must result in the Commissioner receiving from Jetaway more than the Commissioner would receive from Jetaway in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of Jetaway.[1] In particular, the Commissioner says that in a winding up he would have been entitled, under the set-off provision s 553C, to set off against the tax due by Jetaway the diesel fuel rebate the Commissioner owed Jetaway and only prove for the balance.[2] Sub-section 553C(2) provides, however, that a person is not entitled under the section to claim the benefit of a set-off if, at the time of giving credit to a company, or at the time of receiving credit from the company, the person had notice of the fact that the company was insolvent.

6 The liquidators submit that the Commissioner is not entitled to rely on the set-off provision in applying the unfair preference test. In the alternative, the liquidators submit that if the Commissioner is entitled to rely on the set-off provision, then it is not available because the Commissioner had notice of the fact Jetaway was insolvent when the Commissioner gave credit to Jetaway or received credit from Jetaway. Further, the liquidators submit that the Commissioner bears the onus of establishing he did not have such notice at the relevant time.

(a) Are the set-off provisions available to the Commissioner in answer to the unfair preference claim;

(b) If so, who bears the onus of proof on notice of the fact of insolvency; and

(c) Has notice of the fact of insolvency been established?

8 For the following reasons, I have concluded that:

(a) The set-off provisions are available to the Commissioner in answer to the preference claim;

(b) The plaintiffs bear the onus of proof on notice of the fact of insolvency; and

(c) Notice of the fact of insolvency has not been established by the plaintiffs.

ARE THE SET-OFF PROVISIONS AVAILABLE TO THE COMMISSIONER?

9 There is no dispute that in a liquidation the set-off provisions would have been available to the Commissioner but for any issue about notice of the fact of insolvency.

10 The unfair preference provisions of the Corporations Act 2001 were introduced into the Act's predecessor by the Corporate Law Reform Act 1992 and replaced provisions in the then Corporations Law which incorporated the preference provisions from the Bankruptcy Act 1966 to apply to companies.[3] Under the Bankruptcy Act 1966, the transaction was required to have the effect of giving a creditor a "preference priority or advantage" over other creditors. These words were taken to connote some unfair priority or advantage.[4] In forming such a view, the court looked at the "ultimate effect" the transaction had on the financial relationship of the parties.[5]

11 In Re A & J Lazzarotto Pty Ltd,[6] in a preference claim, the Full Court of the Supreme Court of Victoria applied the set-off provisions of the Bankruptcy Act 1966 to determine the ultimate effect of a transaction. There the company owed its directors $7,400 for rent of premises and the directors owed the company $8,620 on a loan account. About a month before the company went into a creditors' voluntary winding up, there was an exchange of cheques for $7,400, satisfying the rent and reducing the loan account. The liquidator sought to set aside as a preference the payment for rent made by the company. The court observed that if the payment had not been made, in the liquidation, the directors could have set off against the loan they owed the company the rent owed to them. The court posed the question whether, by reason of the set-off provisions, the general body of creditors were worse off in the liquidation than they would have been if the transactions had not taken place. The court concluded the transaction had no affect on the payment of the general creditors in the liquidation.

12 The liquidators do not seek to challenge the decision in Re A & J Lazzarotto[7], nor the ultimate effect doctrine under the Bankruptcy Act 1966. The liquidators submit, however, that the set-off provisions could not be availed of to answer an undue preference claim under Part 5.7B. The liquidators submit that Part 5.7B is intended to codify the regime relating to unfair preferences and s 553C is not in Part 5.7B. They submit that the only answer or defence to an unfair preference claim are the defences dealt with in s 588FG under the heading "Transactions not voidable against certain persons." They submit the Commissioner could have raised this defence but that it would have been more onerous to establish than set-off, as the defence would not be available if he suspected Jetaway was insolvent rather than he had notice that Jetaway was in fact insolvent. They submit that as s 553C lies in Part 5.6 it is not available as an answer to the liquidators' claims and that s 588FG was intended to be the sole answer.

13 The liquidators rely on BP Australia Ltd v Brown[8] where Spigelman CJ said Part 5.7B brought together under a single regime various kinds of completed business dealings which are susceptible to subsequent avoidance by the express statutory powers of intervention which are conferred by s 588FF and the specific defences which are generally applicable in s 588FG. The liquidators accept the observations of Ormiston JA in V R Dye v Peninsula Hotels[9] (with which Winneke P and Tadgell JA agreed) that the 1992 amendments to the unfair preference laws were not intended to make any significant different provision for identifying what is an unfair preference, except in a few minor respects and except in so far as the sections now appear in the Corporations Law (as it then was).

14 In my view, the application of the set-off provisions are a necessary part of the ultimate effect of the transaction. In this case, the transactions do not have the effect of giving Jetaway an unfair advantage over other creditors because in the winding up of Jetaway the set-offs would have to be given effect to. In V R Dye v Peninsula Hotels,[10] Ormiston JA held that the ultimate effect principle, as recognised by the High Court in Airservices Australia v Ferrier[11] and Richardson v Commercial Banking Co of Sydney[12] and applied in Re A & J Lazzarotto Pty Ltd,[13] applied to the construction of s 588FA. Consistently, Ormiston JA said that "the new provision should be construed in the same way as the former provision except to the extent that the language of s 588FA clearly points to the contrary provision."[14]

15 The liquidators nevertheless submit that the new provisions make it clear that the only defence available to the undue preference claim is that of s 588FG. I do not agree. Its application is part and parcel of the winding up process. In my opinion, the application of s 553C is not a defence. Its continued application survived the 1992 amendments. The provisions are to be given the widest possible scope.[15] On this basis the liquidator's submission is not made out.

16 Further, even if the ultimate effect doctrine did not survive (save as provided in the running account provision s 588FA(3)) the wording of s 588FA(1)(b) makes clear the application of s 553C is not a defence but a necessary element of the definition of an unfair preference. The section requires the position of the Commissioner, as a result of the transaction, to be compared to the position where he proved for the tax debt in a winding up of Jetaway. If he proved for the tax debt, he would be required by s 553C to set-off the moneys owed to Jetaway and only prove for the balance.

17 Subject to the set-off not being denied by reason of s 553C(2) as discussed next, the Commissioner has not obtained any unfair preference. The Commissioner is in no better position than if the transaction had not taken place and Jetaway had gone into liquidation.

WHO BEARS THE ONUS OF PROOF ON KNOWLEDGE OF FACT OF INSOLVENCY?

No set-off where knowledge that company insolvent

A person is not entitled under this section to claim the benefit of a set-off if, at the time of giving credit to the company, or at the time of receiving credit from the company, the person had notice of the fact that the company was insolvent.

19 The liquidators contend that the Commissioner bears the onus of establishing that he did not have notice of the fact that Jetaway was insolvent at the relevant time.

20 The liquidators put forward no direct authorities to support their contention although they do rely on Cavenett v Commonwealth[16] and Thomas v Hatizpetros.[17] In Cavenett v Commonwealth, the New South Wales Court of Appeal confirmed that where a legislative provision enables a right or liability created by the statute to be defeated, the onus of establishing that the provision applies rests on the party seeking to invoke its operation.[18]

21 The Commissioner is not seeking to bring himself within an exception to otherwise general liability. On the contrary, the liquidators allege that the transactions the Commissioner entered into affected unfair preferences. The Commissioner says that the transactions did not do so by reason of the set-off provisions that apply on a winding up. The position in a winding up is the basis for assessing the alleged preference either under the ultimate effect rule or under the words of s 588FA(2) itself. It is the liquidators who contend that the general provision does not apply by reason of the exception.

22 The Commissioner referred to Derham's, The Law of Set-Off,[19] where Dr Derham says the onus should lie on the trustee in bankruptcy (or liquidator) to establish the requisite notice. Dr Derham cites as authority Thomas v Hatzipetros[20] where Hodgson J said that if the question of notice arose under the set-off provisions in the Bankruptcy Act 1966, the onus of proof is on the trustee in bankruptcy or the liquidator.[21] The liquidators, however, rely on the caveat that Hodgson J made to that proposition where he said the onus could rest on the persons seeking to avail themselves of the set-off provisions in certain circumstances. Hodgson J went on to say that in the case before him, the defendants did bear the onus. The circumstances were as follows. Shortly after winding up proceedings had been commenced, the subject company purchased a bank cheque for $20,000 which was offered to the party bringing the winding up proceedings in full settlement. The cheque was not accepted and returned to a director of the subject company. Contrary to instructions given to the bank by the director, the bank placed the money in a cash management account in that director's name, rather than in the company's name. The amount was subsequently used by the bank to reduce the director's overdraft.

23 The liquidator sought an order that the disposition of the cheque in favour of the director by the bank was void under s 468 of the Corporations Law and sought an order that the bank and the director pay to the liquidator $20,000. Under the terms of s 468 of the Corporations Law, the liquidator would have been entitled to such an order unless the Court otherwise ordered. The bank and the director asked that the court "otherwise order" in terms of s 468 of the Corporations Law.

24 The bank was owed some $300,000 by the company. The bank argued that if they had placed the money in an account for the company, they could have set it off against the company's indebtedness to the bank and thus the company was no worse off for the money being used as it had to meet the director's debt.

25 Hodgson J said in those circumstances the bank bore the onus of establishing the set-off provisions would have been available and bore the onus of showing it would not have been disentitled by reason of notice of insolvency from relying on the set-off.[22]

26 The liquidators submit that by analogy, the Commissioner bears the onus of showing he would not have been disentitled by reason of notice.

27 In my opinion, the analogy is not applicable. In Thomas v Hatzipetros,[23] the liquidator had brought proceedings under s 486 to seek a determination that a disposition was void. The bank was seeking to be excused under the "otherwise orders" provision in s 486 on the basis that the company was not disadvantaged by the disposition. The question did not arise under s 86 of the Bankruptcy Act 1966 itself, but under s 486. In this case, the application of s 553C is directly invoked by the liquidators because it is they who allege the transaction constitutes an unfair preference. It is the liquidators who allege that s 553C(2) applies so that s 553C(1) is not available to the Commissioner in determining whether or not he has received an unfair preference. The set-off provided under s 553C is self-executing in the sense that its operation is automatic and does not depend upon "the option of either party."[24] It operates at the time the liquidation takes effect.[25] Thus in this case, the effect of the impugned transaction is to be compared to the position in the winding up of Jetaway if the set-off had not taken place. The set-off would take effect by reason of the winding up. In my view, the onus would have been on the liquidators to establish that it was not available under s 553C(2).

28 The Commissioner also relies on Re A & J Lazzarotto Pty Ltd.[26] There the Full Court observed, where the creditors had successfully relied on the set-off provisions to establish that the transaction challenged by the liquidator had not affected a preference, advantage or priority, that it was open to the liquidator to seek to show that one or more of the conditions precedent to setting off mutual transactions as provided in s 86 of the Bankruptcy Act 1966 were not satisfied but that no attempt to do so had been made by the liquidator.[27] These observations support the contention that the onus lies on the liquidators to make out notice of insolvency if they seek to deny the creditor the benefit of the set-off provisions.

29 Accordingly, I reject the liquidators' contention that the Commissioner bears the onus.

HAS KNOWLEDGE OF THE FACT OF INSOLVENCY BEEN ESTABLISHED?

What constitutes notice of the fact that the company was insolvent?

30 I was informed that counsel were unable to find any direct authorities on the meaning of notice for the purposes of s 553C.

31 The Commissioner submits that, for the purposes of s 553C, notice of the fact that the company was insolvent would require the Commissioner to know one of the things set out in s 459C(2) of the Companies Act 2001 which sets out the circumstances where a company will be presumed insolvent for the purposes of a winding up on the grounds of insolvency.

32 The Commissioner relies on Law v James[28] where the New South Wales Court of Appeal (Jacobs and Hope JJA) considered what constituted "notice of an available act of bankruptcy committed by that person" as that expression appeared in the set-off provision, s 86, of the Bankruptcy Act 1966; that being the set-off provision incorporated into the then Companies Act 1961. They held that, when applied to a company, the notice was of any act or omission of the company which would found a petition to wind that company up on the grounds that it was unable to pay its debt, including the acts or omissions of a company set out in s 222(2) of the Companies Act 1961. The equivalent provision to s 222(2) of the Companies Act 1961 is now set out in s 459C(2) of the Corporations Act 2001. The significant point, so far as the Commissioner is concerned, is that none of these statutory grounds of presumption include an analysis of the company's financial position, but they all relate to objective matters readily discernible, such as a failure to comply with a statutory demand.

33 The Harmer Report, which led to the Corporation Law Reform Act 1992 that incorporated the unfair preference provisions in the Corporations Law, acknowledged that the set-off provision then appearing in s 86 of the Bankruptcy Act 1966 would need to be included in the Corporations Law. They recommended, however, that on its incorporation, it be amended so that situations for excluding a right of set-off should correspond to the situations where a transaction may be avoided on the basis that it was preferential. Accordingly, the Commission recommended that there be no right of set-off where, at the time of the transaction, the person had reason to suspect that the company was unable to pay its debts.[29] This recommendation was not accepted. As noted above, s 553C requires notice of the fact that the company was insolvent, whereas s 588FG(2), which gives a defence to transactions being voidable, refers to a person having no reasonable grounds for suspecting that the company was insolvent.

34 I accept, therefore, that s 553C requires more than reasonable grounds for suspecting that Jetaway was insolvent at the relevant times or would become insolvent but requires notice of the fact that the company was insolvent. As submitted by the Commissioner, this may be limited to knowledge or notice of one of the grounds set out in s 459C(2) raising a presumption of insolvency for the purposes of winding up an insolvent company. It is, however, unnecessary for me to decide this issue. The liquidators submit that the Commissioner's knowledge of Jetaway's financial position, including its failure to pay the taxes due, would have led him to notice of the fact that the company was unable to pay its debts as they fell due and therefore notice of the fact that the company was insolvent.

35 Assuming that notice of the fact that the company was insolvent could be established in that way, which the Commissioner disputes, I am not satisfied on the evidence that the Commissioner did have notice that the company was unable to pay its debts as they fell due as that phrase has been interpreted and applied by the Courts in determining whether or not the company was insolvent.

36 To deal with the liquidators' submission, it is necessary to consider what constitutes knowledge to the Commissioner for the purposes of this question. Principles of equity lie at the heart of company law. The Court of Chancery initially administered the winding up of companies rather than the Court of Bankruptcy.[30] I am prepared to assume, therefore, without necessarily deciding the issue, that equitable principles of knowledge may be applied in considering whether knowledge has been made out. Thus the knowledge will not be limited to actual subjective knowledge. Equity will impute knowledge in certain circumstances.

37 I will assume for present purposes, without deciding the issue, that the principles that equity applies to assessing knowledge where it is alleged a defendant assists a trustee or fiduciary with knowledge of a dishonest and fraudulent design on the part of the trustee or fiduciary for the purpose of the second limb of Barnes v Addy[31] would be sufficient to establish the relevant knowledge under s 553C. The High Court in Farah Constructions v Say-Dee Pty Ltd[32] has recently confirmed that knowledge for the purposes of the second limb of Barnes v Addy includes (1) actual knowledge; (2) wilfully shutting one's eyes to the obvious; (3) wilfully and recklessly failing to make such inquiries as an honest and reasonable man would make; and (4) knowledge of circumstances which would indicate the facts to an honest and reasonable man. Thus, mere negligent failure to make inquiries is not sufficient.

38 In my opinion, that standard might be appropriate when considering the purpose of the section. An obtuse creditor would not escape the provision if a reasonable person would have concluded from the facts known to the creditor the fact that the company is insolvent. It is not suggested in this case that the Commissioner had actual knowledge of the fact of insolvency or that he wilfully shut his eyes to the obvious. Wilful recklessness was not relied on either, although wilful blindness was pressed. I do not accept wilful blindness on the part of the relevant tax officers. Accordingly, the test that the liquidators have to establish is that the Commissioner had notice of facts that would have indicated to a reasonable person the fact that Jetaway was insolvent. There is no issue in this case that the facts known to the relevant public servants can be imputed to the Commissioner.[33] I turn now to the facts relied on by the liquidators.

The matters relied on by the liquidators as constituting notice

39 Jetaway was required to make monthly Business Activity Statements (BAS) for each month and for each quarter. Until late 2003, the company had met its obligations of filing its BAS returns and paying the amount due. In January 2004, an automatic letter of demand was sent on default of paying the amount due under the November 2003 BAS return. Failure to comply with that letter prompted the matter to be referred to the then Debt (Campaigns) section of the Australian Tax Office. Speaking generally, this section contacted taxpayers who were obliged to file BAS returns and had failed to pay the tax due. The section was entitled to enter into arrangements giving taxpayers time to pay. If those arrangements were not met and a new arrangement was not entered into the matter could be referred to the pre-legals section to commence legal action. No evidence was led what the authority of the pre-legals section was or what sections would review the matter above it before a winding up proceedings might be instituted. The Commissioner submitted that I should infer that the pre-legals section would not have such authority.

40 In granting an arrangement the officers of the section were bound by the ATO Receivables Policy. Under 10.3.4 of chapter 10 the Commissioner accepted that some taxpayers may occasionally experience cash flow difficulties that will prevent them from paying their debt on time. In those isolated instances, the Commissioner would consider requests to accept payment of the debt by instalments over a period of time. Under 10.3.8, the policy provided that taxpayers may be asked to complete an application form and the onus was on taxpayers to satisfy the Commissioner they cannot pay by the due date (as opposed to will not pay at all).

41 As a consequence of the failure of Jetaway to respond to the letter of demand, Maria Roccioletti, an officer with a classification of Australian Public Service level 3, contacted Jetaway and spoke to Mr Baker the Chief Financial Officer of the company. She recorded the conversation in what is called a narrative which is added to the taxpayer's file. She recorded that he told her that Jetaway was unable to pay in November 2003 due to insufficient funds. He said that after "redirecting" the company and being able to "educate" their debtors they are now able to pay the whole debt in full including $215,077.73 due on 23 February 2004. This was the November 2003 BAS sum due in December 2004. She agreed to extend time for payment of that sum to that date.

42 It was not paid as promised. On 27 February 2004, Ms Roccioletti contacted Mr Baker again. He apologised and said that the company had received funds and he promised payment would definitely be made on 5 March 2004.

43 She agreed to a new arrangement which included the amount due on the January 2004 BAS return of $70,000 as well as the November BAS sum of $215,077.73. The December 2004 BAS amount had been paid in February. Mr Baker was warned that default would trigger legal action.

44 Payment was not made as promised. On 9 March 2004, Ms Roccioletti again spoke to Mr Baker. He claimed that he had given instructions for payment to be made and had been on holiday. She asked him to confirm by noon that day that payment had been made. He was warned that if payment was not made the matter would go to pre-legals to proceed to legal action.

45 On 16 March 2004, Jetaway gave the Tax Office authority to set off fuel grants against tax liabilities. Subsequently, on 18 March 2004, Mrs Roccioletti spoke to Mr Baker and asked why payment had not been made on 9 March as agreed. Mr Baker informed her that the company had insufficient funds to commit at present. A further arrangement was discussed that fuel grants would be used to extinguish existing debts but on condition the company would honour all future obligations including the February 2004 BAS.

46 On 30 March 2004, Mr Baker was informed this arrangement was not put in place as the February 2004 BAS had not been lodged or paid. Mr Baker informed Mrs Roccioletti that the company would be able to meet all their future obligations within two weeks as the company was refinancing and the cash flow problem would be solved. On this basis, Mrs Roccioletti agreed to a new arrangement for the fuel grant to be used to pay all existing liabilities including the February BAS again on condition that all future obligations would be met.

47 On 23 April 2004, Mr Barry McCann, who had taken over from Mr Baker, requested a new arrangement to include the March BAS. Mrs Roccioletti agreed to the new arrangement whereby the tax debt which had grown to $553,692.19 would be met by the application of the fuel grants. Mrs Roccioletti spoke to Mr McCann on 5 May 2004 and told Mrs Roccioletti that the company would be able to comply in full as the company was going through to refinance to amend its cash flow problem. At that stage, Mrs Roccioletti reviewed the compliance history of Jetaway and noted it had been complying up to 22 December 2003.

48 On 24 May 2004, Jetaway lodged its April BAS. At that stage the company's debt to the Tax Office stood at $789,406.64. On 24 May 2004, the company faxed Mrs Roccioletti informing her that Jetaway was unable to pay its April BAS of $238,739 by 21 May 2004. Jetaway informed Mrs Roccioletti that the company was in the process of changing factoring companies, hopefully by the end of the week, which should improve their cash flow, as funds would be available daily. Jetaway asked that the Tax Office defer legal proceedings. Mrs Roccioletti noted that no reply was made to the fax as the payment arrangement was still active and transfer of funds from fuel grants had been made. No explanation was provided why Mrs Roccioletti considered the arrangement was still active in view of Jetaway's failure to pay the April BAS.

49 After 24 May 2004, there was no further communication with the section. No further BAS statements were lodged. Thereafter fuel grant set offs were applied to Jetaway's debt to the Tax Office on 28 May 2004, 9 July 2004, 19 August 2004 and 25 August 2004. Jetaway went into administration on 6 September 2004.

Do these facts establish the Commissioner had notice of the fact that Jetaway was insolvent?

50 The facts known to the Commissioner may have given him reasonable grounds for suspecting that Jetaway was insolvent.[34] I am not satisfied, however, that the Commissioner had notice of the fact that Jetaway was insolvent.

51 Under s 95A of the Corporations Act 2001, a person who is not solvent is insolvent and 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. In Sandell v Porter,[35] Barwick CJ addressed the issue of insolvency under the Bankruptcy Act 1924-1960 which referred to an inability to pay debts as they fall due out of the debtor's own money. The Corporations Act 2001 omits the reference to debtor's own money but is otherwise similar. The omission is not relevant for present purposes.[36] Barwick CJ said:

The conclusion of insolvency ought to be clear from a consideration of the debtor's financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor's inability, utilising such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency. Whether that state of his affairs has arrived is a question for the court and not one to which expert evidence may be given in terms though no doubt experts may speak as to the likelihood of any of the debtor's assets or capacities yielding ready cash in sufficient time to meet the debts as they fall due.[37]

As an aside, the reference to the matter being one for the court and not one to which expert evidence may be given, supports the Commissioner's argument that notice of insolvency should be limited to matters giving rise to a presumption of insolvency under the Corporations Act 2001, rather than an analysis of the financial position of the debtor as suggested by the liquidator.

52 Assuming, however, notice can be derived by an analysis of the financial position of the debtor, it is apparent in this case that the Commissioner did not have information on the debtor's financial position in its entirety. All the Commissioner was aware of was evidence of a temporary lack of liquidity. Generally speaking, Barwick CJ expressly rejects that as a basis for concluding insolvency. The Commissioner was aware that GST was payable by Jetaway on freight it invoiced, rather than the freight it was paid for and that a failure to factor the debts owed to Jetaway could well lead to temporary illiquidity affecting its ability to pay GST.

53 As indicated above, I am not satisfied, even on the test propounded by the liquidators, that the Commissioner had the requisite notice.

54 I therefore find that the set-off transactions did not constitute unfair preferences and that the liquidators have not established that the Commissioner would not have been entitled to the set-off provisions in a winding up of Jetaway if the transactions had not taken place.

55 Accordingly, I dismiss the plaintiffs' application with costs.

BEFORE THE HONOURABLE THE CHIEF JUSTICE (SIR JOHN YOUNG),

IN THE MATTER of the Companies Act 1961

FULLAGAR, J.: This is an appeal from an order made by Kaye, J., upon a

liquidator's summons, that a payment made by a company now in liquidation was void as a preference (Companies Act 1961, s.293).

The company, A. and J. Lazzarotto Pty. Ltd., was incorporated on 7 October 1968. The present appellants, respondents to the liquidator's summons, Gino and Antonio John Lazzarotto, were the sole shareholders and directors. The company lent to them the sum of $25,000 with which, in 1969, they purchased a property known as 349 Darebin Street, Northcote. Pursuant to some unwritten arrangement, the company used this property in connection with its business of engineering and concreting contracting as a depot and storage yard. As rent for this occupation it paid, by journal entries, the sums of $3,640 on 30 June 1970, $6,020 on 30 April 1971, and $4,380 on 30 June 1971, and these amounts were credited to the appellants in satisfaction pro tanto of their debt of $25,000. Late in 1971 the company ceased business and sold assets previously used in its business.

On 16 March 1972, pursuant to the advice of an accountant, by an exchange of cheque the company paid to the appellants the sum of $7,400 purporting to be rent, and the appellants paid to the company an identical amount in reduction of their debt. Immediately before this transaction the company's bank balance was insufficient to cover its cheque, and the balance of the loan debt in the company's books was, to the nearest dollar, $8,620.

On 13 April 1972 the company was placed in creditors' voluntary winding up. By a summons dated 13 October 1976 the liquidator asked for an order that the payment of $7,400 made to the company in March 1972 constituted a preference and was void. The liquidator's affidavit referred to the payment as made "in respect of the said rent", and did not attempt to show that it was not paid in respect of rent. In the liquidation there was a deficiency of $127,615 after taking into account the value of the remaining assets at $4,150.

His honour made the order sought by the liquidator. In giving judgment he said that in opposition to the summons Richardson v. Commercial Banking Co. of Sydney Ltd. [1952] HCA 8; (1952) 85 C.L.R. 110, Queensland Bacon Pty. Ltd. V. Rees [1966] HCA 21; (1966) 115 C.L.R. 266 and Calzeturificio Zenity Pty. Ltd. (In liquidation) v. New South Wales Leather Trading Co. Pty. Ltd. [1970] VicRp 80; (1970) V.R. 605 had been relied on by counsel for the appellants in support of an argument that the transaction relating to the payment of the rent and repayment of the loan must be regarded as a whole, but His Honour rejected this argument, finding that the payment of rent impugned by the summons did not form part of a continuing arrangement between the company and the appellants a condition of which was that upon each payment of rent a sum equal to the payment should be paid to the company in reduction of the loan account. He held that the payment was made in the manner adopted as the result of an ad hoc arrangement designed to promote the interests of the appellants. Accordingly, the payment constituted a preference of the appellants as against the general body of unsecured creditors, since the company was insolvent at the time of the transaction of 16 March. He then held that the appellants were not entitled to set off the debt due to them for rent against the debt due by them on the loan account. He said that the provisions of Bankruptcy Act, 1966-1973, s.86, did not enable a creditor to set off a debt due to him from the company which was the subject of a preferential payment against a liability of his own to the company. In reaching this decision, His Honour relied upon a line of authority beginning with In Re A Debtor [1927] 1 Ch. 410, and including Re Grezzane, Painter and Charles Whiting and Chambers Ltd. (1932) 4 A.B.C. 203; Re Smith, ex parte Tully (1933) 6 A.B.C. 49; Re Clements, ex parte Goldsbrough Mort & Co. Ltd. (1933) 7 A.B.C. 255 and the Calzaturificio Zenity Pty. Ltd. Case (above) at p.618.

On this appeal Mr Robson, who appeared for the appellants, argued that the principle to be derived from cases such as Richardson's Case and the Queensland Bacon Case was not dependent upon the proof of a continuing course of conduct, but in essence was that the whole of a transaction, even if an ad hoc transaction, had to be regarded in deciding whether a payment which was part of the transaction constituted a preference. The essence of his argument, however, was that in determining whether the payment was a preference or not, the decision was to be made upon a consideration of the effect of the transaction on the appellants and the general creditors in the subsequent liquidation. What was to be considered was whether the appellants were better off in the liquidation as a result of the transaction than they would have been if the company had proceeded into liquidation without the transaction having been effected, and that involved the question other creditors were adversely affected in respect of their rights in the liquidation by what had been done. He argued that the line of authorities starting with In Re a Debtor, 1927, established only that orders for repayment of moneys found to have been paid by way of preference could not be set off by the creditor against debts due to him. Mr. Jordan, who appeared for the liquidator, argued that the principle illustrated by Richardson's Case and the Queensland Bacon Case was only applicable where the entire transaction resulted in an increase in the assets of the company in liquidation approximately equal to the diminution of its assets resulting from the payment under challenge. He contended that there was no increase in assets here corresponding to the diminution resulting from the payment. He also argued that the only set off contemplated by s.86 was one made in the course of the administration of the winding-up by the liquidator or of a bankruptcy by the Official Receiver. It was not open to the parties to call the section in aid of the effectiveness of a transaction carried out privately between them before the liquidation.

It is important to realise that in these proceedings the facts that the payment made by the company to the appellants was in respect of rent, and was the correct amount owing for rent at the date on which it was made, were not challenged. The result was that the Court was considering the case on the basis that there was an undisputed and correctly quantified claim for rent, and an undisputed and correctly quantified obligation on the part of the appellants in respect of money lent to them by the company. The learned Judge, after voicing doubts about the classification of the payments in 1970, 1971 and 1972, finally said that he was not satisfied that there was on the 16 March 1972 a sum of $7,400 owing by the company for rent. The case, however, had been brought to Court by the liquidator upon the basis or assumption that a debt due for rent had been paid, and in the form which these proceedings took it was not open to the learned Judge to take any other view.

The effect of the transaction of 16 March was that no tangible assets changed hands. On the other hand, the liabilities of the company were reduced by $7,400, and the appellants' claims for this amount was completely satisfied. The company's assets were reduced by the reduction of the debt owing by the appellants from $8,620 to $1,220. From this it was argued that a preference had been effected by the rent payment, because the appellants had in respect of that payment been paid in full, and the creditors generally, who could only expect a dividend because the company was already insolvent, were left with reduced assets out of which the dividend could be paid.

In our opinion, the answer to this is to be found in a sentence in Richardson's Case at p.129. The Court there said:

"Section 95" (now s.122) "supposes a bankruptcy, and it is in relation to that bankruptcy that the question arises whether, over the other creditors, a preference priority or advantage has been given to the particular creditor."

The general proposition so stated appears in a form directly related to the present problem in the following statement in Williams, The Bankruptcy Act 1914, 18th ed. P.392:

"A payment to a creditor who is himself a debtor of the amount paid in discharge of his debt, resulting in the discharge of cross-claims of equal amount, cannot be a voidable preference, as the right of set-off would have remained in bankruptcy, so that no one is harmed by the transaction."

The learned editors refer to an exception to this rule in the case of companies in liquidation illustrated by In re Washington Diamond Mining Co. 1893 3 Ch. 95, but In re B.P. Fowler Ltd. 1938 Ch. 113 it was pointed out that that exception was applicable only where the debt due to the company was for calls on shares. In Burns v. Stapleton [1959] HCA 34; 1959 102 C.L.R. 97 at 104 the High Court said:

"What the subsection" (the former s.95(1), now s.122(1)) "clearly intends to make void, where it applies, is the change which, if allowed to be effectual, would dislocate the statutory order of priorities amongst the creditors."

In the present case, if one asks whether the appellants were better off, or the general body of creditors were worse of in the liquidation of the company than they would have been if the transaction of 16 March had not been carried out, the answer is that their position was unchanged by it, because one appellants' obligation in respect of the liquidation, by virtue of the set off provisions of s.86, ....... to pay to the liquidator the sum of $1,220, and this was exactly what it would have been if the transaction of 16 March had not been carried out. Nor has there been any other intermediate change in the assets of the company apart from the reduction in the amount of the debt owed by the applicants, a reduction which for the reasons stated has no effect on the payment of the general creditors in the liquidation.

The principle of Richardson's Case is relevant to the present case only because it shows that the whole transaction which in fact is agreed upon and carried out must be regarded for the purpose of determining what the effect of one component part of it is. That decision makes it clear that questions of the enforceability of the alleged agreement are irrelevant, and so also is the possibility that one party, having derived the advantage given to him by the agreement, may not honour his own obligations under the agreement. If the agreement is in fact made, and fully carried out, it is the effect of the performed agreement which the Court must assess. It is therefore not permissible in the present case to separate the payment for rent from the cross-payment in respect of the loan.

Mr. Jordan's argument that it is not open to the parties to give effect by private arrangement to the right of set off is met by saying that if the appellants, under the arrangement, received a benefit which they would not have been entitled to receive by way of set off in the liquidation, then they have had a preference, but it cannot be said that they have received a preference if it appears that they would have been entitled to the same set off in the liquidation. It was open to the liquidator in these proceedings to seek to show that one or more of the conditions precedent to setting off mutual transactions as provided in s.86 were not satisfied. No attempt to do so was made.

Accordingly, in our opinion it was not shown that the appellants obtained a preference by the transaction of 16 March, and the appeal accordingly must be allowed and the order below set aside, and in lieu thereof there should be substituted an order that the liquidator's summons be dismissed. The liquidator must pay the appellants' costs both here and in the court below.

[1] See s 588FA(1)(b) of the Corporations Act 2001

1. [2] Section 553C of the Corporations Act 2001:

Insolvent companies - mutual credit and set off

(1) Subject to subsection (2), where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company:

(a) an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and

(b) the sum due from the one party is to be set off against any sum due from the other party; and

(c) only the balance of the account is admissible to proof against the company, or is payable to the company, as the case may be.

(2) A person is not entitled under this section to claim the benefit of a set-off if, at the time of giving credit to the company, or at the time of receiving credit from the company, the person had notice of the fact that the company was insolvent.

[3] See history discussed in V R Dye v Peninsula Hotels [1999] VSCA 60; [1999] 3 VR 201

[5] Airservices Australia v Ferrier (1996) 185 CLR 483 per Dawson, Gaudron and McHugh JJ at 509

[6] (Unreported, Full Court of the Supreme Court of Victoria, Young CJ, Lush and Fullagar JJ, 16 December 1977). The report is annexed to this judgment as it is not readily available.

[8] [2003] NSWCA 216; (2003) 58 NSWLR 322 at [90] - [91]

[9] [1999] VSCA 60; [1999] 3 VR 201 at [27]

[12] (1952) 85 CLR 100

[13] (Unreported, Full Court of the Supreme Court of Victoria, Young CJ, Lush and Fullagar JJ, 16 December 1977)

[15] JLF Bakeries Pty Ltd (in liq) v Baker's Delight Holdings Ltd (2007) 25 ACLC 1164; Gye v McIntyre [1991] HCA 60; (1991) 171 CLR 609

[16] [2007] VSCA 88

[17] (1997) 24 ACSR 286 (SCNSW)

[18] Ibid [36]; see also Dowling v Bowie [1952] HCA 63; (1952) 86 CLR 136 per Dixon CJ at 139-140

[19] Rory Derham, The Law of Set-Off (3rd Ed, 2003) at [6.79]

[20] (1997) 24 ACSR 286 (SCNSW)

[23] (1997) 24 ACSR 286 (SC NSW)

[24] See Gye v McIntyre [1991] HCA 60; (1991) 171 CLR 609 at 622 per Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ citing with approval Lord Selborne LC in Re Deveze; Ex parte Barnett (1874) 9 Ch App 293 at 295

[26] (Unreported, Full Court of the Supreme Court of Victoria, Young CJ, Lush and Fullagar JJ, 16 December 1977)

[28] [1972] 2 NSWLR 573

[29] The Law Reform Commission, Report No. 45, General Insolvency Inquiry, Volume 1, para 818 and 819

[30] CCA v Harvey [1980] VicRp 64; [1980] VR 669 per Marks J at 682

[31] (1874) LR 9 Ch App 244

[32] [2007] HCA 22; (2007) 230 CLR 89 per Gleeson CJ, Gummow, Callinan, Heydon and Crennan JJ at 163

[33] In D'Aloia v Commissioner of Taxation of the Commonwealth of Australia [2003] FCA 1336; [2003] 203 ALR 609, Merkel J addresses the elements of knowledge for purposes of s 588FG(2)(b)(i) and (ii). His discussion suggests that the test I am applying may be too generous to the liquidator.

[34] D'Aloia v Commissioner of Taxation of the Commonwealth of Australia [2003] FCA 1336; [2003] 203 ALR 609

[35] [1966] HCA 28; (1966) 115 CLR 666

[36] Crema v Land Mark [2006] VSC 338; (2006) 58 ACSR 631 at [138] - [145]

[37] Ibid, 670 - 671; see also discussion on insolvency by Dodds-Streeton J in Crema v Land Mark [2006] VSC 338; (2006) 58 ACSR 631 at [138] - [145] and Austin Australia Pty Ltd v De Martin and Gasparini Pty Ltd [2007] NSWSC 1238 at [7] - [8]