Good faith in insolvency revisited

The recent Western Australian Court of Appeal decision of Hayden Leigh White in his Capacity as Joint and Several Liquidator of Port Village Accommodation Pty Ltd (in Liquidation) v ACN 153 153 731 Pty Ltd (in liquidation) (PVA)[1] reversed the decision at first instance in White & Templeton v ACN 153 152 731 Pty Ltd (in liquidation) (White)[2], with regard to the statutory defence for unfair preferences under section 588FG of the Corporations Act 2001 (Cth) (the Act), commonly referred to as the ‘good faith’ defence.

Background

The liquidators of a company, Port Village Accommodation Pty Ltd (the Company) sought to recover alleged preferential payments made to the second defendant, Hickory Group Pty Ltd (Hickory), the parent company of the first defendant, Hickory Group WA Pty Ltd (HWA), for payments made in the course of a building contract. Hickory claimed the payments were made in good faith and could therefore rely on the defence under section 588FG of the Act. Master Sanderson held that the defence applied.  However, the Court of Appeal later reversed the decision and provided guidance on the parameters of the good faith defence - in particular, the scope of the reasonable person test applicable to the test.

Applying the reasonableness test in s588FG

By way of background, an unfair preference occurs when a transaction results in a creditor receiving from a company, in relation to an unsecured debt owed to the creditor, a greater amount than it would have received in a winding up of the company.  The “good faith defence” allows a creditor to retain the benefit of the transaction, so long as the requirements in section 588FG are met.

A creditor wishing to rely on section 588FG must establish that:

1.          they had become a party to the transaction in good faith; and

2.          that:
(a)        they had no reasonable grounds for suspecting that the company was insolvent; and
(b)        that a personable person in the circumstances had no reasonable grounds for suspecting that the company was insolvent.

In the first instance, Master Sanderson had held that for the purposes of the second limb of the second test, the ‘reasonable person’ was not a ‘reasonable business man’, but, in the circumstances, the test referred to a ‘reasonable person managing a business supplying goods and materials in the building industry’.[3]

The Court of Appeal preferred a different approach in stating that Master Sanderson’s application of the test deflect[ed] attention from the correct starting point, which is the hypothetical, average, reasonable business person’.[4] Master Sanderson’s interpretation was founded on subjective considerations of whether that particular creditor and their skill, training and experience would have had reasonable grounds for suspecting insolvency. In effect, the Master’s interpretation meant that if the creditor had no actual knowledge of insolvency of the payer, had no reasonable grounds for suspecting insolvency of the payer, and was deemed to be a reasonable person, then the hypothetical ‘reasonable person test’ would be satisfied.

The Court of Appeal took a different view.  Instead, the Court considered that the correct approach was to consider 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 Hickory’s circumstances were sufficient to induce a suspicion as to insolvency.[5]  This is distinct from whether or not the actual person had reasonable grounds for suspecting insolvency of the payer.

The Court of Appeal qualified this by suggesting that subjective facts can be incorporated into the ‘reasonable person’ test, so long as they can be proven to be common industry practice. In this case, the subjective appreciation of events by Hickory’s representative were considered by the master in his finding that there was no fundamental problem with the financial viability of the Company. The Court of Appeal suggested that the Master should have instead found, as a matter of fact, whether the periods of delay in payment were consistent with industry practices.[6]

Going forward

PVA is particularly instructive, insofar as it assists in clarifying the matters to be considered and assessed when determining whether the good faith defence can be availed. Specifically, the standard of objectivity appears to require consideration of:

(a)         first, the objective reasonable business person, with no regard to subjective considerations of the actual creditor nor his/her/its position, skills, mindset nor background;

(b)         second, subjective considerations that could potentially impact the assessment of the objective reasonable business person in subparagraph (a) above.

It is a subtle – but nevertheless important distinction – that ought not to be confused in assessing the ‘influence’ of subjective matters to the objective standard.   Put simply, what can be considered are holistic, macro factors (such as industry practice) that may impact on the objectivity of the average business person, and what ought not be considered are personal, specific and micro factors of that particular creditor.

For further advice or assistance, please contact Paul Mac

Article published by Paul Mac, Makan Mirzai and Amy Barcock.


[1] Hayden Leigh White in his Capacity as Joint and Several Liquidator of Port Village Accommodation Pty Ltd (in Liquidation) v ACN 153 153 731 Pty Ltd (in Liquidation) (2018) ACSR 182 (PVA).

[2] White & Templeton v ACN 153 152 731 Pty Ltd (in Liquidation) [201] WASC 52 (White).

[3] White, [40].

[4] PVA, [139].

[5] Ibid, [126].

[6] Ibid, [142].