Bankruptcy Notices and going behind the Judgment

I was recently involved in a matter (that settled, rendering some questions posed by this article moot, for the moment) which involved an application to set aside a Bankruptcy Notice, as there was no “real debt owing”.

I was briefed to defend the application on behalf of the creditor, who came to me in disbelief (as was I) to the unusual nature of the application. However, on further reading, there seems to be case law to support it, however, respectfully, may be premised on interpretation of an High Court authority, to which I submit, was not intended to create such a precedent. In any event, let’s explore …

The Bankruptcy Court’s Power to go behind a Judgment

Section 52 of the Bankruptcy Act 1969 (Cth) provides:

Proceedings and order on creditor's petition

(1) At the hearing of a creditor's petition, the Court shall require proof of:

(a) the matters stated in the petition (for which purpose the Court may accept the affidavit verifying the petition as sufficient);

              (b) service of the petition; and

(c) the fact that the debt or debts on which the petitioning creditor relies is or are still owing;

and, if it is satisfied with the proof of those matters, may make a sequestration order against the estate of the debtor.

In Wren v Mahoney (1972) 126 CLR 212, which was decided in the context of section 52 of the Bankruptcy Act 1966 (Cth), in determining a creditor’s petition, Barwick CJ said at [4]:

“Section 52 of the Bankruptcy Act requires that the Bankruptcy Court should, amongst other things, be satisfied by proof of the debt of the petitioning creditor and that if and when satisfied of that proof the Court may make a sequestration order in pursuance of the petition.”

This was emphasised in the decision of Ramsay Health Care Australia Pty Ltd v Compton [2017] HCA 28, in which a joint judgment of their Honours, Kiefel CJ, Keane and Nettle JJ, said at [1]:

 “A Bankruptcy Court exercising jurisdiction under s 52 of the Bankruptcy Act 1966 (Cth) ("the Act") may, in some circumstances, "go behind" a judgment in order to be satisfied that the debt relied upon by the petitioning creditor is truly owing. The Bankruptcy Court may take this course in order to satisfy itself that there is an extant petitioning creditor's debt as a necessary foundation for the making of a sequestration order.”

The Bankruptcy Court’s Power to set aside a Bankruptcy Notice

Section 40 (1) (g) Bankruptcy Act 1966 (Cth) provides;

Acts of bankruptcy

 (1) A debtor commits an act of bankruptcy in each of the following cases:

(g) if a creditor who has obtained against the debtor a final judgment or final order, being a judgment or order the execution of which has not been stayed, has served on the debtor in Australia or, by leave of the Court, elsewhere, a bankruptcy notice under this Act and the debtor does not:

(i) where the notice was served in Australia--within the time specified in the notice; or

(ii) where the notice was served elsewhere--within the time fixed for the purpose by the order giving leave to effect the service;

comply with the requirements of the notice or satisfy the Court that he or she has a counter-claim, set-off or cross demand equal to or exceeding the amount of the judgment debt or sum payable under the final order, as the case may be, being a counter-claim, set-off or cross demand that he or she could not have set up in the action or proceeding in which the judgment or order was obtained;

How recent decisions have interpreted s 40 (1) (g) and s 52 together

On reading of the above, it is my view that it is not available to an applicant to set aside a bankruptcy notice in line with s 52 and the principles in Wren v Mahoney. However, these two sections have a long line of interpretation, and such applications allowed, which I submit is outside the scope of s 40(1)(g), yet, currently my view, it seems, is incorrect at Law.

His Honour Judge Manousaridis, has covered the overlapping interpretation on a number of occasions. Most recently in his decision in the matter of Kuhadas v Gomez [2014] FCCA 1130. His Honour, very helpfully, discusses in detail the power conferred by both s 52 and s 40(1)(g) in conjunction with each other, at [19] – [27] of his Judgment. Specifically, he addresses the power as follows, at [23] and [26]:

[23]“A bankruptcy court’s power to go behind a judgment has most often been exercised at the hearing of a creditor’s petition under s.52(1) of the Act. The nature and the reasons for the exercise of the power of going behind a judgment were amply described in the following passage from the judgment of the plurality in Corney v Brien:

 “Section 56 (2) (a) of the Bankruptcy Act 1924-1950 provides that the court at the hearing shall require proof of the debt of the petitioning creditor. Under this provision the Court of Bankruptcy has undoubted jurisdiction to go behind a judgment obtained by default or compromise or where fraud or collusion is alleged and inquire whether the judgment is founded on a real debt. In Ex parte Kibble . . . Sir W.M. James L.J. said: "It is the settled rule of the Court of Bankruptcy, on which we have always acted, that the Court of Bankruptcy can inquire into the consideration for a judgment debt". Sir G. Mellish L.J. said: "It is quite clear that in the Court of Bankruptcy the consideration for a judgment may be investigated, particularly when the judgment has gone by default" . . . . This case was discussed and followed in Ex parte Lennox . . . where the reasons why the Court of Bankruptcy will go behind a judgment debt are fully discussed. Lindley L.J. said that "the Court of Bankruptcy will not allow itself to be put in motion at the instance of a person who is not a real creditor" . . . In In re Fraser . . . Kay L.J. said: "It is old law in bankruptcy that, neither upon an attempt to prove a debt, nor upon a petition for an adjudication of bankruptcy or a receiving order against a debtor, is a judgment against him for the debt conclusive. In Ex parte Bryant . . . Lord Eldon said: 'Proof upon a Judgment will not stand merely upon that, if there is not a Debt due in Truth and Reality, for which the Consideration must be looked to'." In In re Gooch . . . Scrutton L.J. said: "The county court registrar held quite correctly that he was at liberty to go behind the judgment, and see whether there was a good debt to support it". In In re a Debtor . . . Astbury J. said "True it is that the Bankruptcy Court may, upon a prima-facie case being shown, go behind a judgment for the purpose of satisfying itself that the debt enforceable thereunder was a real debt." In Petrie v. Redmond, a case in this Court . . . Latham C.J. said: "The court (that is, the Court of Bankruptcy) is entitled to go behind the judgment and inquire into the validity of the debt where there has been fraud, collusion or miscarriage of justice. . . . Also the court looks with suspicion on consent judgments and default judgments." “

 [26] “The court’s power to go behind a judgment debt that is exercised on an application for a sequestration order is available to be exercised after a bankruptcy notice demanding payment of the judgment debt has been issued but before the time for complying with it has expired. It is available to be exercised on an application to set aside a bankruptcy notice.”[1]

 Thus, it appears that there is a common law power, conveyed on a Bankruptcy Court, to ensure that any act taken by a creditor founded on a Judgment, must have a debt due “in truth and reality”. Although, I submit it is at odds with the specific limitations of which a debtor may set aside a Bankruptcy Notice under s 40(1)(g), the Bankruptcy Court, has the power to go behind the Judgment, on an application to set aside a Bankruptcy Notice.

When should this power be applied?

However, simply because the power exists, doesn’t entitle its application. It is a discretionary power and is usually applied in ensuring the interests of justice. His Honour Judge Manousaridis, again, helpfully sets out the discretionary power and when it should be applied, Kuhadas v Gomez [2014] FCCA 1130 at [24] – [25]

[24] “A court of bankruptcy will not, however, go behind a judgment as a matter of course. It will do so only in certain circumstances. The circumstances in which it will do so have been described in different ways. In Corney v Brien the plurality said that s.56(2)(a) of the Bankruptcy Act 1924-1950 (Cth), which in substance was the same as s.52(1)(c), conferred “undoubted jurisdiction to go behind a judgment obtained by default or compromise or where fraud or collusion is alleged and inquire whether the judgment is founded on a real debt”. In Wren v Mahony Barwick CJ (with whose reasons Windeyer and Owen JJ agreed) said:

Circumstances tending to show fraud or collusion or miscarriage of justice or that a compromise was not a fair and reasonable one, in the sense that even if not fraudulent it was foolish, absurd and improper, or resulted from an unequal position of the parties . . . offer occasions for the exercise by the Court of Bankruptcy of its power to inquire into the consideration for the judgment.

[25] In the same case, Barwick CJ stated in broader terms the circumstances in which a court of bankruptcy may go behind a judgment:

The judgment is never conclusive in bankruptcy. . . . But the Bankruptcy Court may accept the judgment as satisfactory proof of the petitioning creditor’s debt. In that sense that court has a discretion. It may or may not so accept the judgment. But it has been made quite clear by the decisions of the past that where reason is shown for questioning whether behind the judgment or as it is said, as the consideration for it, there was in truth and reality a debt due to the petitioning creditor, the Court of Bankruptcy can no longer accept the judgment as such satisfactory proof. It must then exercise its power, or if you will, its discretion to look at what is behind the judgment. . . . The Court’s discretion in my opinion is a discretion to accept the judgment as satisfactory proof of that debt. That discretion is not well exercised where substantial reasons are given for questioning whether behind that judgment there was in truth and reality a debt due to the petitioner.” “

Substantial reasons being along the lines of ensuring that there was no miscarriage of Justice in the creditor obtaining the underlying Judgment, will generally render the Court to apply its discretion to go behind the Judgment.

Key takeaways

When receiving instructions on either side of a Bankruptcy Notice or Creditor’s Petition, based on a Judgment, it is prudent to first question whether there is any debt due in truth and reality in that Judgment. This will then force one to consider whether the client has prospects of making an application to set aside a notice or successfully defend a petition, or conversely, may be at risk of failing to enforce the notice or to obtain a sequestration order.

Further, and as is always generally accepted in Bankruptcy Courts, any actions in Bankruptcy should be as a last resort and should not be used as debt collection method.

If you have any questions about this article or any similar matters you require assistance with, please do not hesitate to contact me.   

[1] Olivieri v Stafford (1989) 91 ALR 91 at pages 107-109 and in particular the discussion by Gummow J of Wilkinson v Osborne & Anor [1915] HCA 92; (1915) 21 CLR 89, Re Vernon Arnfield [1925] NSWStRp 63; (1925) 25 SR (NSW) 517 and Re Riviere; Ex parte Original Mont de Piete Ltd [1919] NSWStRp 56; (1919) 20 SR (NSW) 77.