It is a defence to an unfair preference claim to show there were no reasonable grounds to suspect the insolvency of the debtor company.
Referred to as the ‘good faith defence’, the creditor has the onus of establishing the defence contained in section 588FG(2) of the Corporations Act 2001 (Cth).
Suspicion of insolvency
The courts have identified the following principles with respect to the good faith defence:
- It is both a subjective and objective test.
- The objective element requires the application of the reasonable business purpose test.
- Suspicion is something that, in all the circumstances, would create in the mind of a reasonable person, in the position of the creditor, an actual apprehension or fear of insolvency.
- The relevant suspicion is one of actual and existing insolvency, as distinct from impending or potential insolvency.
What matters is not the actual situation of the debtor company’s finances, but what information the creditor had and whether it gave reasonable grounds to suspect that the company was insolvent. The defence will not be satisfied if the creditor ignores an objectively obvious insolvency.
There is generally no single factor which invariably establishes that there was, or should have been, reasonable grounds for suspicion.
Once the factors pointing to insolvency have been identified, it is then necessary to ascertain which of those factors were apparent to the creditor, and what cumulative impact that knowledge had or should have had on the creditor.
There may be countervailing factors and circumstances to be weighed in the balance, which could have tended to dispel the suspicion at the relevant time.
A recent decision
In the matter of Conspect Construction Pty Limited (in liquidation) v Andrade Holdings Pty Ltd  WASC 70, the liquidator argued that the following facts showed there were reasonable grounds to suspect insolvency:
- A number of undisputed invoices were unpaid for a significant period of time.
- The creditor informed the debtor, by emails, that payment was urgent and that court proceedings would be commenced if the amount was not paid.
- There was a partial, rounded payment not applicable to any specific invoice.
- The creditor commenced debt recovery proceedings in the Magistrates Court to obtain payment.
- In settlement of the court proceedings, a settlement deed was entered into where the directors of the debtor company guaranteed the payment of the settlement instalments if the creditor was later required to repay any of the instalments to an external administrator as a preferential payment or on any other ground.
The creditor argued it did not have reasonable grounds to suspect insolvency for the following reasons:
- The debtor made various payments to the creditor.
- The creditor’s invoices were genuinely disputed by the debtor.
- The debtor defended the Magistrates Court proceedings.
- The fact that the settlement deed included a personal guarantee by the directors of the debtor would lead a reasonable person to suspect that the debtor was solvent, because directors would not, or would be less likely to, provide a personal guarantee in circumstances where a company was insolvent.
- The director’s guarantee was consistent with a guarantee clause that was drafted to cover all possible contingencies, not as a reflection of a suspicion of insolvency.
- The debtor paid the first instalment in accordance with the terms of the settlement deed.
On the basis of the evidence, the court said that there were no reasonable grounds to suspect insolvency, because:
- there was a genuine dispute relating to the invoices and the court proceedings were defended
- the director’s guarantee was one of a raft of contingency scenarios placed in the settlement deed
- the first instalment under the settlement deed was paid on time.
The Court said that, although there was a persistent failure of the debtor company to pay invoices issued by the creditor, mere failure to pay debts on time does not, by itself, constitute grounds for suspecting insolvency. The Court applied the decision in Metcalf Crane Services Pty Ltd v Rathner  VSC 195.
Taking into account the relevant circumstances, the Court held that there were no reasonable grounds upon which either the creditor, or any reasonable person in the creditor’s circumstances, would have had a reasonable suspicion of insolvency of the debtor company.
Whether a creditor can successfully rely on the good faith defence will depend on the specific facts and circumstances of the creditor’s dealings with the debtor company. The facts are not looked at retrospectively but are looked at through the contemporary eyes of the parties.