Suspicious minds: Creditors bear heavy onus in establishing no suspicion of insolvency

A recent decision of the Supreme Court of Queensland Court of Appeal has provided a useful reminder that a defendant creditor bears a heavy onus in establishing the defence to a voidable transaction claim under s 588FG(2) of the Corporations Act¹ .

Background 

Queensland Quarry Group Pty Ltd (in liq) (Quarry) & Anor v Cosgrove (Cosgrove)² was an appeal from a decision of the District Court of Queensland³ which found that admitted voidable transaction payments (two unfair preference payments of $45,000 and $50,000) were not required to be repaid to the liquidator of Quarry under s 588FF(1) of the Act.

The uncontentious facts of the matter included that:

• In early 2013 Quarry and Cosgrove (and others) had discussed a proposed joint venture to own and operate a quarry and to develop the subject land.
• In October 2013 Quarry (as tenant) and Cosgrove (as owner) entered into a lease enabling Quarry to use the land for quarry extraction, with rent and royalty fees to be paid to Cosgrove.
• In December 2013 Cosgrove sought to be substituted as petitioning creditor in an existing application by a third party for the winding up of Quarry on the basis of unpaid amounts owing under the lease, but reached a settlement with Quarry which involved Quarry paying approximately $10,000.
• In February 2014 Cosgrove sued Quarry for approximately $250,000 in unpaid royalty fees and subsequently retook possession of the land. 
• In March 2014, in ongoing proceedings between the parties in respect of the land, Cosgrove filed submissions indicating that any undertaking provided by Quarry as to damages would be ‘worthless’ due to Quarry’s financial circumstances.
• Under a settlement reached between the parties in April 2014, Cosgrove agreed to sell the land (ultimately to Quarry) and Quarry agreed to pay various amounts to Cosgrove.
• Over 6 months various negotiations followed in respect of the land and the amounts to be paid to Cosgrove, which payments were not made.
• In September 2014 Cosgrove issued a statutory demand for $45,000 and in October 2019 commenced fresh winding up proceedings against Quarry.  
• These proceedings were also settled, and Quarry made payments of $45,000 (in respect of a debt) and $50,000 (in respect of rent arrears) to Cosgrove in October and November 2014.
• Quarry subsequently breached the terms of the settlement agreement.
• In February 2015 new winding up proceedings were commenced by another party, WZL Haulage Pty Ltd.  Cosgrove successfully applied to be substituted as petitioning creditor in those proceedings and obtained orders to wind up Quarry.

Cosgrove admitted that the two payments of $45,000 and $50,000 were unfair preferences but successfully argued at trial that it did not have reasonable grounds for suspecting that Quarry was insolvent.

Decision

Counsel for the liquidator submitted that the Judge at first instance had erred in allowing Cosgrove to rely on the s 588FG(2) defence for several reasons including:

• Failing to apply the correct test for a defence under s 588FG(2).
• Giving undue weight to Cosgrove’s subjective beliefs about Quarry’s circumstances.
• Failing to properly consider how a reasonable business person would have interpreted Quarry’s circumstances.
• Failing to give sufficient weight to objective matters and indicia concerning Quarry’s insolvency

The QLD Court of Appeal confirmed that the correct test is as set out in the decision in White v ACN 153 152 731 Pty Ltd (in liq) (White)⁴ where the WA Court of Appeal described the ‘hybrid test’ under section 588FG(2)(b) in the following terms:

Accordingly, the question raised by the first limb is whether the facts and matters actually appreciated by 'the person', ie, the particular creditor, were sufficient to induce a suspicion as to insolvency in the mind of a reasonable person. The question raised by the second limb is whether the facts and matters which would have been appreciated by a hypothetical person with the knowledge and experience of the average business person in the creditor's circumstances, were sufficient to induce a suspicion as to insolvency in such a hypothetical person. In each case, the negative must be proved by the creditor.

Ultimately the QLD Court of Appeal found that the history of litigation and unpaid debts as between Cosgrove and Quarry outlined above, meant that by at least October 2014 there were sufficient available and objective facts to support a reasonable suspicion that Quarry was actually insolvent.  

The QLD Court of Appeal then considered the various factors identified by Cosgrove and the Judge at first instance as having ‘dispelled’ the reasonable suspicion of insolvency.  The factors included the possibility that the delays in payment were just part of a pattern of conduct by Quarry, and that Cosgrove thought that Quarry’s business was going well by observations of trucks attending the quarry site.  The QLD Court of Appeal found that not only were these factors not reasonable, but also that a reasonable person in Cosgrove’s position would not have overcome any suspicion of insolvency based on these factors.

Importantly, the QLD Court of Appeal observed that:

Referring to possible explanations for [Quarry’s] breaches… or other defaults in payment of debts, does not advance the defence.  The onus under s 588FG(2)(b)(ii) is on the creditor.  It is for the creditor to exclude other rational hypotheses as to the failure to pay debts as and when they fall due.  If insolvency remains as one rational hypothesis, the onus has not been discharged.

The QLD Court of Appeal allowed the appeal and ordered repayment of the $45,000 and $50,000 plus interest.

Lavan comment

This decision is consistent with the recent decision of the Court of Appeal of Western Australia in White in re-affirming that in order to establish the defence under s 588FG(2) a defendant creditor must show that there were “no reasonable grounds for suspecting” insolvency.

That means that the creditor has to establish a negative, recognised by authority as a substantial task, namely that the matters appreciated by that creditor were insufficient to induce a suspicion of insolvency both for the creditor and for a reasonable business person in the creditor’s circumstances.

As the decision shows, this is a high bar for creditors to overcome.