This week’s TGIF considers the case of Compton v Ramsay Health Care Australia Pty Ltd [2016] FCAFC 106, where the Court exercised its power to “go behind” a judgment upon which a petitioning creditor relied as proof of a debt that was owed.

WHAT HAPPENED?

On 4 June 2015, a creditor filed a creditor’s petition in the Federal Court seeking a sequestration order against the estate of the debtor, after the debtor failed to comply with a bankruptcy notice. The bankruptcy notice required payment of a judgment order made by the Supreme Court of New South Wales in the amount of $9,810,312, arising from a personal guarantee provided by the debtor.

In the Supreme Court proceeding, the debtor did not dispute the quantum of the claim. Rather, he contended that although he had signed certain pages, those pages were signed to signify his assent to a separate guarantee and one which would not expose him to personal liability.

The Supreme Court rejected these contentions and gave judgment in favour of the creditor for the amount claimed.

When the petition was filed in the Federal Court, the debtor asked the Court to separately determine whether it should “go behind” the Supreme Court judgment and question whether there was, in fact, a debt owing to the creditor.

THE DECISION AT FIRST INSTANCE

The power to go behind a judgment upon which a creditor relies is provided in sections 52(1) and (2) of the Bankruptcy Act 1966 (Cth). This requires a court of bankruptcy to be satisfied that the debt on which the petitioning creditor relies is still owing.

Before the Federal Court, the debtor led evidence to the effect that when all monies were accounted for, the creditor actually owed money to the debtor’s business. The creditor conceded that whilst it was an “open question” as to whether certain amounts were in fact owing by it to the debtor, the debtor had appeared at a contested trial where the issue now sought to be raised could have been, but was not, raised.

The primary judge considered that the discretion to “go behind” the Supreme Court judgment was not enlivened because:

  1. the debtor participated in and was represented by counsel in the three day Supreme Court proceeding;
  2. there was available evidence filed in the Supreme Court (but not read) addressing the quantum of any liability owed to the creditor;
  3. a forensic decision was made to confine the issue to be resolved to the enforceability of the guarantee; and
  4. no explanation had been advanced on behalf of the debtor as to why the quantum of any indebtedness was not put in issue before the Supreme Court.

DECISION ON APPEAL

The Full Federal Court observed that the primary judge had focused primarily on the way in which the debtor conducted his case in the Supreme Court, rather than on the central issue, which was whether reason was shown for questioning whether behind the judgment, there was in truth and reality a debt due to the petitioning creditor.

The Court noted that had the focus been on the central issue, the answer would have been quite different, as the evidence disclosed substantial reasons for questioning whether the debtor was indebted to the creditor.

The Court acknowledged that the debtor had the opportunity to challenge the quantum of any liability in the Supreme Court proceeding but chose not to do so. However, it held that the focus for the bankruptcy court is not on the forensic choices made by the parties in the litigation which resulted in the judgment, but on the requirement that there be satisfactory proof of the petitioning creditor’s debt.

For these reasons, the Court concluded that the primary judge had erred and ordered that the separate question, being whether the Court should “go behind” the judgment of the Supreme Court, be answered in the affirmative.

COMMENT

This case demonstrates that, in certain circumstances, the Court may exercise its discretion and question whether there is in truth and reality any debt owing to the petitioning creditor. The discretion exists due to the particular nature of bankruptcy litigation and the effect of a bankruptcy order on both the debtor and other creditors.

While parties will generally be held to the way in which they conduct their case, the Court still requires proof that the debt on which the petitioning creditor relies is still owing. This applies even when the judgment debt ordered to be paid follows a contested hearing on the merits.