Open Season on Judgment Debts in Bankruptcy Proceedings

In a decision of considerable concern to creditors¹, the High Court has determined that a bankruptcy notice founded on a judgment debt is open to challenge on the basis that there is a “sufficient reason” for questioning the underlying debt – even if that judgment was the product of a fully contested trial in which both parties were legally represented, and was not procured by fraud or collusion.

As a result of this decision, creditors (and the Courts) can expect more challenges to bankruptcy notices and more judgment debtors seeking to introduce fresh evidence to cast doubt on the underlying debts.

Background

When making a sequestration order, the Bankruptcy Act requires the Court to be satisfied that the debt on which the petitioning creditor relies is still owing. In doing so, the overwhelmingly accepted practice in bankruptcy proceedings is to treat judgment debts as conclusive evidence that the petitioning creditor has a valid and enforceable debt. Historical anomalies aside, the only exceptions to this well-founded practice being:

• default judgments (ie judgments entered without any determination of the merits)
• judgments obtained by fraud or collusion and
• judgments that are on appeal.

The High Court’s decision in Ramsay means that judgment creditors can no longer be confident that the Bankruptcy Court will accept a finally determined judgment as reliable evidence of the relevant debt.

The decision

In Ramsay, the creditor had sued the debtor in the Supreme Court under a guarantee. The debtor (who was legally represented) defended the claim on the basis that he was mistaken about the meaning of the guarantee when he signed it. He did not dispute the quantum of his indebtedness. The Court did not accept his defence and, after a contested hearing, the Court entered judgment for the amount claimed. The debtor did not appeal, and the creditor then served a bankruptcy notice requiring that he pay the judgment debt. The debtor did not comply, and the creditor then applied for a sequestration order in the Federal Court.

In the bankruptcy proceeding, the debtor opposed the creditor’s petition and contended that the Court should exercise its discretion to “go behind” the judgment upon which the petition was based and consider whether the amount of the claimed debt was actually owing. In doing so, the debtor introduced fresh evidence that he was entitled to various “offsets” and “rebates” from the creditor, such that the creditor may in truth and reality be indebted to the debtor. There was no suggestion that the judgment was obtained by fraud or collusion.

At first instance, the primary judge declined to go behind the judgment debt for reasons including:

1. the judgment debtor was represented by Counsel before the Supreme Court
2. the factual matters relating to the “offsets” and “rebates” were available to the debtor at the time of the Supreme Court hearing
3. a forensic decision had been made by the judgment debtor not to challenge the quantum of his indebtedness before the Supreme Court and
4. no explanation had been provided as to why the quantum of indebtedness was not put in issue before the Supreme Court.

The debtor successfully appealed to the Full Federal Court, which appeal was upheld by a majority of the High Court. Relevantly, the majority held that:

1. the Bankruptcy Act imposes an obligation on the Bankruptcy Court to be satisfied that the debt on which the petitioning creditor relies is still owing. That obligation serves to protect third party creditors whose interest in being paid their debts in full should not be prejudiced by the making of a sequestration order in reliance on a judgment debt which does not reflect the true indebtedness of the debtor to the petitioning creditor
2. the Court may go behind a judgment debt (obtained after a contested hearing) where there has been a “miscarriage of justice”, which in this context is not limited to cases where the judgment is so tainted that it may be set aside and
3. the fact that a judgment was obtained without collusion or fraud after a contested hearing does not preclude the possibility of there being “sufficient reason” for questioning the underlying debt.

The majority rejected the creditor’s arguments that the Court should have regard to the principles of finality in litigation and that the Bankruptcy Court should “not become an appeal court from other tribunals”.

Comment

The High Court’s decision is an unfortunate development in the law of bankruptcy. It creates uncertainty, raises an additional obstacle to creditors seeking to enforce judgment debts, and will likely lead to more litigation and a greater number of appeals.

Nevertheless, it is hoped that the Bankruptcy Court will apply the High Court’s reasoning consistent with common sense and exercise their discretion to go behind judgment debts (obtained after contested hearings) only in exceptional circumstances. Watch this space.

¹Ramsay Health Care Australia Pty Ltd v Adrian John Compton [2017] HCA 28 (Ramsay)